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Bank credit appraisal criteria for borrowing firms in vietnam

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UNIVERSITY OF ECONOMICS

INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLANDS


VIETNAM- NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

BANK CREDIT APPRAISAL CRITERIA
FOR BORROWING FIRMS IN VIETNAM
A thesis submitted in partial fulfilment of the requirements. for the degree of


t

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LE DiNH THUY NGAN
Academic Supervisor:

Asso.Prof.TRUONG QUANG THONG

HO CHI MINH CITY, DECEMBER 2010

-

-~


CERTIFICATION
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I hereby certify that the substance of this thesis has not been submitted for any
degrees and is not being currently submitted for any other degrees.

I also certify that, to the best of my knowledge, and any help received in
preparing the thesis and all sources used have been acknowledged in the thesis .

.

Signature

'
LeDinh Thuy Ngan
Date: December, 2010




...

...... · ~

_-


ACKNOWLEDGEMENT



This research 1s impossibly completed without the valuable guidance,
encouragement and advice from numerous individuals including VietnamNetherlands program lecturers, friends and my family members. I am really
indebted and grateful to what they have done for my thesis completion.
First of all, I would like to send my deepest gratitude to my supervisor, Professor
Truang Quang Thong who always gives advice and comments during my
completion of the thesis.
I am grateful for Professor Nguy~n TrQng Hoai and Professor Peter Calkins for
their precious advice and comments from the initial ideas of the theme for my
thesis .


Many especially respectful thanks are sent to my family for encouraging and
providing me with an opportunity to pursue my desires in higher learning and for
their love, affection and sympathy that have helped me to gain more strength and
motive to complete this thesis.


LIST OFT ABLES

..

Table 2.1: Rating symbols long-term and short-term debt

II

Table 2.2: Weighted points of non-financial criteria

14

Table 2.3: Weighted points of financial ratios and non-financial criteria

15

Table 2.4: Weighted points of financial ratios and non-financial criteria

15

Table 2.5: Rating symbols ofVCB

16

Table 2.6: Profit and tax with two different capital structure

18

Table 3.1: Sort credit rating business

25

Table 3.2: Business structure has ability to repay

26

Table 4.1: Following explain the meaning of variables (see appendix 1)

31

Table 4.2: Points of cash flow factor

37

Table 4.3: Points of management quality factor

38

Table 4.4: Points of relations with banks factor (see appendix 3)

39

Table 4.5: Points of business environment factor

40

Table 4.6: Points of other activities factor

41

Table 5.1: Descriptive Statistics

44

Table 5.2: Correlations (see appendix 4)

45

Table 5.3: Model summary (see appendix 5)

46

Table 5.4: Anova

46

Table 5.5: Coefficients of models (see appendix 6)

46

Table 5.6: Distribution graph

48

Table 5.7: Spearman rank correlation

48

Table 5.8: Standardized residual graph

49


ABBREVIATIONS

BIDV: Bank for Investment and Development of Vietnam
CIC: Credit information center
EBIT: Earning before tax and interest rate
EU: Europe
FDI: Foreign Direct Investment
GDP: Gross Domestic Products
GSO: General Statistics Office ofVietnam
MM: Modiglian Miller
SBV: State Bank of Vietnam
SMEs: Small Medium Enterprises

U.S.: United States
VCB (Vietcombank): Bank for Foreign Trade of Vietnam
WACC: Weighted average cost of capital

..


ABSTRACT

Capital credit is very important in business activities of enterprises. The
ability to repay loans model in this thesis shows an important role when the
bank make a lending decision. This study examines and analyses credit
rating criteria affecting borrowing firms on bank credit appraisal in
Vietnam through applying cross-section data from Credit Information
Center which concentrate on forty firms including the medium-sized
enterprises that has equity capital more than five billions Vietnam dong or
number labor more than two hundred people in leather-footwear industry.
The regression model is estimated based on the multiple linear regression
function. The ability to repay loans is dependent variable in the thesis
model, and independent variables are current ratio, quick ratio, inventory
turnover, receivable turnover, total asset turnover, debt to equity ratio,
debt to total asset ratio, return on asset, return on common equity ratio, net
profit margin ratio, delinquency ratio, cash flow, management quality, the
relations with banks, business environment, other activities and corporate
income tax (new added). As results, corporate income tax factor affecting
Vietnam. Moreover, the results seem to be appropriate to answer questions
of the research, borrowing firms are perceived to be information on the
lending decision at banks in


TABLE OF CONTENTS

LIST OF TABLES
ABBREVIATIONS
ABSTRACT
CHAPTER 1:

INTRODUCTION

1.1. Problem statement

1

1.2. Research objective

3

1.3. Research questions

5

1.4. Methodology

6

1.5. The structure ofthesis

6

CHAPTER 2: LITERATURE REVIEW
2.1. Theory background
;

1

7

7

2.1.1. Credit appraisal

7

2.1.2. The definition of credit rating

8

2.1.3. Objective of credit rating

8

2.1.4. Role of credit rating

8

2.1.5. Principle credit rating

8

2.1.6. Credit rating model

9

2.1. 7. The basic elements of credit rating

9

2.1. 7.1. The number ranks of credit rating

9

2.1. 7.2. Scale of criteria

10

2.2. Some model of credit rating

10

2.2.1. Moody's rating analysis

10

2.2.2. Z-score model of Altman

12

2.2.3. Credit rating of credit information center

13

2.2.4. Credit rating VCB

13

2.3. Corporate income tax

17

2.3.1 Assumptions and proposition ofM&M theory

17

2.3.2 MM proposition I (corporate taxes)- The value of levered firm

17

2.3.3 Optimal capital structure theory

20


2.4. Summary

21

CHAPTER 3: OVERVIEW OF LEATHER -

FOOTWEAR INDUSTRY

IN VIETNAM
3 .1. Reasons of using data in Vietnam's leather - footwear industry

23

3.2. Overview ofleather- footwear industry in Vietnam

23

3.3. Credit ratings data ofthe leather-footwear industry in year 2008

24

3.4. Summary

27

CHAPTER 4: METHODOLOGY

28

4.1. The econometric design

28

4.2. Suggested research model

29

4.3. The conceptual design

32

4.3.1. Criteria that banks use to appraise

'

23

32

4.3.1.1 Current ratio- CR

32

4.3.1.2. Quick ratio- QR

33

4.3.1.3. Inventory turnover- IA
4.3.1.4. Receivable turnover- RT

34

4.3.1.5. Total asset turnover- TAT

34

4.3.1.6. Debt to total asset ratio - DA

35

4.3.1.7. Debt to equity ratio- DE

35

4.3.1.8. Net Profit margin- NPM

36

4.3.1.9. Return on assets - ROA

36

4.3.1.10. Return on Equity- ROE

36

4.3.1.11. Cash flow- CF

37

4.3.1.12. Management quality- MQ

.)

4.3.1.13. Relations with banks- RB

39

4.3.1.14. Business environment- BE

39

4.3.1.15. Other activities- OA

41

4.3.1.16. Delinquency ratio- DR

42

4.3.2. Corporate income tax (new factor)- CIT

, g1-'l
J

42

4.4. Data collection method

43

4.5. Summary

43


CHAPTER 5: DATA PROCESSING AND EMPIRICAL RESULTS
5.1. Descriptive statistics
5.2. Regression and hypothesis testing

44
44
45

5.2.1. Correlation analysis

45

5.2.2. Evaluating the reliability of multiple linear regression model

45

5.2.3. Test the relevance of the overall regression model

46

5.2.4. Test the significance of partial regression coefficients

46

5.2.5. Assumption of multiple linear regression model

47

5.2.5.1. Linearity Assumption

47

5.2.5.2. Homoscedasticity

48

5.2.5.3. Distribution standard of residual

49

5.2.5.4. No-serial correlation

49

5.2.5.5. Collinearity diagnostic

50

5.3. Summary
CHAPTER 6: CONCLUSION

50
51

REFERENCE
APPENDIX 1

iv

APPENDIX2

v

APPENDIX3

V111

APPENDIX4
APPENDIX 5
APPENDIX6

ix
X

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CHAPTER 1:
INTRODUCTION

This chapter starts with introduction to problem statement. It then presents
research objectives, questions and methodology in sections: 1.2, 1.3 and 1.4,
respectively. Finally, this chapter show thesis structure in section 1.5.
1.1. Problem statement

The world economy is currently undergoing a severe crisis. The cause of the
crisis is following:
- Objectively, on the theory, growth and development economic generally
follows cycle. After a period of extreme development, it will reach the top,
followed by a recession cycle. With this perspective, the world economy
developed rapidly in last years of previous century and peaked during the period
2001-2007.
- Subjectively, these are the errors in the management economy of
economic times "digital" - "virtual economy", particularly in management of
financial system, money and banks, namely approximately six percents of all
mortgage loans in United States were in default in 2008. Historically, defaults
were less than one-third of that, i.e., from 0.25% to 2%.
The crisis began with the collapse of Bank Lehman Brother Investment, one
ofthe largest banks in the United States, on 9 June 2008 (BBC News, 2008). As
year progressed, the United States banking and financial system, followed by the
EU and Japan, were all shaken by the crash of multiple banking, corporate
finance-insurance institutions.
In the first three months of 2009, the situation continued to deteriorate, with
GDP growth in most of developed countries dropped to around negative 2.2
percent. Trade turnover reduced strong (export of Eastern Asia reduced 30%,


I •

developing countries reduced over 10%) and high rates of unemployment that
had never been seen in decades such as unemployment rate of United States is
8.1 percent with over 5 million workers, unemployment rate of Japan is 4.4
percent with nearly 3 million workers, unemployment rate of EU is 7.6 percent
with nearly 4. 7 million workers (Nguyen Dang Hung, 2009).
With most developing economies, including Vietnam, to subjective effort,
growth and development depends on two fields: export-import and capital
resource. Growth indicators, FDI, turnover export during the end of the year
2008 to the present, all indicated that the crisis is affected by the economicfinancial global on the economy of Vietnam: GDP in 2008 adjusted to 6% (2009
adjusted also decline 6-6.5% to 5-6%, while EU predicted about GDP increased
only 0.3%); FDI in the first two months of 2009 with only 5 billion USD (by
31% in the same year 2008); unemployment increased (Ministry of Foreign
Affairs Vietnam, 2009).
In the banking sector, under the guidance of the Government and the Prime
Minister, to stabling economic growth, the orientation of credit growth m
Vietnam must maintain credit growth and ensure credit quality. Hence, to
achieve credit growth in years after 2008, namely banks need to search new
added corporate income tax factor in credit appraisal to increase loans but
ensuring repayment ability of borrowers. It is the motivation for present thesis on
credit appraisal criteria for borrowing firms in Vietnam banking.
The main objective ofthis thesis is to determine new factor (corporate income
tax factor) affect the ability to repay loans of borrowers in Vietnam. Factors
which banks are used in credit appraisal are: current ratio, quick ratio, inventory
turnover, receivable turnover, total asset turnover, debt to equity ratio, debt to
total asset, return on asset, return on common equity, net profit margin,
delinquency ratio, cash flow, quality management, relations with banks, business

2


environment, other activities, and factor is proposed to apply in credit appraisal
ofVietnam banking now is corporate income tax factor.
The regression model is used to estimate ability to repay loans of the
borrowers. Then, banks decide to rely on repayment ability. In this model of
thesis, dependent variable is ability to repay loans of the firms for the banks to
lending decisions.
1.2. Research objective

The objective of this thesis is to analyze corporate income tax factor which is
proposed to add in 16 factors are used in credit appraisal in order to determine
debt repayment ability of borrowers. Beside many criteria are used in banks such
as current ratio, quick ratio, inventory turnover, receivable turnover, total asset
turnover, debt to equity ratio, debt to total asset ratio, return on asset ratio, return
on common equity ratio, net profit margin ratio, delinquency ratio, cash flow,
management quality, the relations with banks, business environment and other
activities, this thesis find out about level influence of corporate income tax factor
in credit appraisal.
Because corporate income tax is an expense, on one hand, enterprises tend to
find ways to set the tax shields such as increased use of debt instead of equity, on
the other hand, minimizing corporate income tax and some savings will
contribute to increasing business value. With new factor added (corporate income
tax factor), if enterprises have an optimal capital structure and saving corporate
income tax, their value may be increased. Then, the bank's credibility with the
borrowers will increase. Thus, banks may increase limit loans for enterprises to
increase outstanding loans but ensuring credit quality.
With new factor added (corporate income tax), banks can extend credit, credit
quality, to improve business performance and bring other social benefits; this is
presented clearly in the diagram below:

3


DECI~EASF:

CONTRIBUTING
CORPORATE INCOME TAX

GOVERNMENT

INCREASE GDP & CONTRIBUTING
OTHER TAXES BY OTHER
INVESTMENT

Source: Author 2009

4


The map shows that saving corporate income tax of enterprises affect lending
decision of bank credit appraisal. It increases limit loans of banks but securing
credit quality. The map framework is presented as follows:
Having equation is need for capitals of enterprises equal bank loans plus
contributed capital and thence bank loans equal need for capital of enterprises
minus contributed capital.
In case, if enterprises have capital structure to save corporate income tax, they
will use a part of contributed capital to other investment and the other investment
will bring profit for businesses. When enterprises use contributed capital for
other investment, contributed capital of equation above reduce respectively.
Consequently, need for bank loans increase and it made an increase in interest
loans expenses, leading enterprises to save corporate income tax.
Thus, if enterprises have an optimal capital structure for saving corporate
income tax, confidence level of banks with enterprises will increase in credit
appraisal. Since then, banks can increase limit loans for borrowers. Hence, banks
will improve business performance, credit growth, but ensuring credit quality.
Besides, while enterprises use loans to saving corporate income tax,
enterprise use contribution capital for other investment and the effect of other
investment brings social benefits (such as GDP growth, contribute corporate
income taxes).
1.3. Research questions

For enterprises, corporate income tax is an expense. It is shown on the
financial report of business. Thus, financial decisions are often considered and
reviewed in the environment taxes. Because interest expense are recorded as
expenses before calculating corporate income tax, businesses tend to borrow
more debt to have greater tax shield and profits for businesses will increase,
ensuring the financial management objectives. Therefore, research topics select
corporate income tax factor to consider the impact of this new factor added to

5


Bank credit rating criteria impact directly and indirectly on loans between lender
and borrower by arithmetic to measure ability to repay loans of enterprises for bank
to lending decisions.
4.3. The conceptual design

According to Ross (2005), financial ratios are useful indicators of a firm's
performance and financial situation. Most ratios can be calculated from
information provided by financial statements. Financial ratios can be used to
analyze trends and to compare firm's financials to those of other firms. So,
financial ratios criteria of enterprises are essential criteria in credit appraisal for
lending decision of banks.
4.3.1. Criteria that banks use to appraise
4.3.1.1. Current ratio- CR

Current ratio is ratio of current assets to current liabilities:
Current Assets
Current Ratio=------Current Liabilities
Short-term creditors prefer a high current ratio since it reduces their risk.
Shareholders may prefer a lower current ratio so that most of the firm's assets are
working to grow enterprises. Typical values for current ratio vary by enterprise
and industry. One disadvantage of the current ratio is that inventory may include
many items that are difficult to liquidate quickly and have uncertain liquidation
values.
Current ratio reflects ability to pay liabilities of enterprises. According to
common expenence,
If CR < 1, the liquidity of business is low
If CR > 1, the liquidity of business is high

32


decide the banks' lending in credit appraisal. Thus, research questions are posed
as:


What criteria are currently used in banks for credit rating of

enterprises in credit appraisal in Vietnam?


Does corporate income tax factor affect lending decision of banks

in credit appraisal?
1.4. Methodology

The data collection will be processed by SPSS software. After getting the
necessary

information,

quantitative

analysis,

statistical

descriptive

and

econometric methods will be used to analyze that information. Form that
analysis, we have a general understanding about 16 factors are used in credit
appraisal and corporate income tax factor that affect ability to repay loans to
lending decisions of banks. This analysis also provides hypothesis tests of the
relationships between each independent variables and the dependent variable.
The econometric method is OLS regression to estimate the effects all factors on
ability to repay loans. Also the relationships among independent variables are
tested and checked for the correlations.
1.5. The structure of thesis

In addition to introduction chapter, the rest of the paper consists of 5 chapters
with the outline as follows:
Chapter 1: Introduction
Chapter 2: Literature review
Chapter 3: Overview of leather - footwear industry in Vietnam
Chapter 4: Research methodology
Chapter 5: Data analysis
Chapter 6: Conclusions

6


CHAPTER2:
LITERATURE REVIEW
2.1. Theory background

In granted credit, lending activity is important because it makes up the largest
proportion in business operation of banks (Karel, 2008). Before making any
lending decisions, credit appraisal should be completed as part of the screening
process (Limsombunchai et al., 2005).
2.1.1. Credit appraisal

According to Bhattacharya (1998), credit appraisal is to use the tools and
techniques to analyze the inspection, evaluation of reliability and risk of a plan or
projects that the customer has to show for the lending decision.
The purpose of credit appraisal is to assess accurate and true ability to repay
debt of enterprises to making any lending decisions (Jonathan, 2001). Main
content of a typical credit appraisal are as follows:


Borrower status



Financial situation of customer



Feasibility of the investment projects



Loan property guarantee



Ability to manage and control risks

Thus, credit appraisal is one of the important steps in all process credit.
According to Nguyen Minh Kieu (2008), the importance of it is represented as
follows:


Assess the reliability of production plan or investment projects that
borrowers have provided for banks when they do loan procedures.



Analyze and evaluate the level of risk of the project when banks decide to
lend money.
7



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Help creditors and banking leaders in lending decisions and reduce the
rate of two kinds of mistakes in lending decisions: (1) lending for a bad
project and (2) deny loan for a good project.

2.1.2. The definition of credit rating

A credit rating is "an opinion on the future ability and legal obligation of an
issuer to make timely payments of principal and interest on a specific fixed
income security" (Moody's, 2004).
A credit rating is an assessment of the credit worthiness of individuals and
enterprises. It is an evaluation about the history of borrowing and repayment, as
well as the availability of assets and extent of liabilities (Steven, 2003).
2.1.3. Objective of credit rating

Credit rating is part of credit appraisal relating to level of trust by banks for
businesses. The commercial banks do not use credit rating results to evaluate the
value of borrowers. Credit rating is basically a formed opinion based on current
credit appraisal criteria which banks will examine and determine loan limits
accordingly (Vietcombank, 2008).
2.1.4. Role of credit rating

Credit rating helps commercial banks to control the confidence level of
clients, set interest rates for loans in accordance with the ability to predict failure
of each customer group. Commercial banks can evaluate effective list for loans
through monitoring the change of outstanding debts and debt classification in
each group of customers who has a credit rating, thereby adjusting list of priority
resources to customers safely (Nguyen Thanh Huyen, 2008).
2.1.5. Principle credit rating

Concepts of modem credit rating are focused on key principles including
trustable analysis based on awareness and goodwill payment by borrowers and
the loan; evaluation of long-term risk based on the influence of business cycle
and trends capacity repayment in the future; and comprehensive assessment
based on credit rating symbols.
8


In analyzing method, credit rating is essential in the use of qualitative analysis
as supplement to the quantitative analysis (United Nations, 2008). The
quantitative data are the observers to be measured by number; the observations
can not measure by number to be assigned to the qualitative data. Those of
analysis may change in accordance with changes in the level of technology
requirements.
2.1.6. Credit rating model

Simple model to be used in the credit rating model is a variable model. The
evaluation criteria should be unified in the model. Financial ratios are used in the
model include liquidity ratios, debt ratios, coverage ratios, activity ratios,
profitability ratios and interest costs. And non-financial criteria are used in the
model include the operation of enterprises, number of years of quality and level
of high-level management, and industry prospects. A disadvantage of a variable
model is that the result is difficult to predict accurately if the analysis performed
and the number of points assessed separately, many people can understand the
criteria evaluated by a difference. To overcome the disadvantage, these
researchers have developed models to combine multiple variables to a value so
the ability to repay loans of the enterprises, such as: Linear discriminant model
(Lee, 2007) and Logistic regression model (Andre, 2009).
2.1. 7. The basic elements of credit rating
2.1.7.1. The number ranks of credit rating

Determining the number of rank in credit rating is very important. The
number of rank must certain to cover all trust levels of borrowers at the banks.
On the other hand, the number of rank must ensure in such a way that businesses
have the same trust level must ensure the same rank and this same rank must
reflect correct level of trust.
In the world today, there are many organizations making credit rating for
businesses. Each organization has the rank to different rating. Rating by Standard
& Poor's, one of the prestige credit rating companies in the United States and the
9


world, including 10 rankings such as AAA, AA, A, BBB, BB, B, CCC, CC, C,
D, with AAA is highest rating (Standard & Poor's, 2006). Moody's has the
ranking system such as Aaa, Aal, Aa2, Aa3, Al, A2, A3, Baal, Baa2, Baa3,
Bal, Ba2, Ba3, Bl, B2, B3, Caal, Caa2, Caa3, Ca, C with Aaa rank is highest
rating. Fitchrating has long-term rating scales such as AAA AA, A, BBB, BB, B,
CCC, CC, C, D with AAA ranking is highest rating (Fitchrating, 2006).
Generally, credit rating consists of 10 levels from AAA to D and is used
commonly in the trust ranking organization in the world.
In Vietnam, credit rating at bank as BIDV, Vietinbank, Vietcombank
including 10 ranks namely AAA, AA, A, BBB, BB, B, CCC, CC, C, D (AAA highest grade and D - lowest grade), is evaluated from the financial and nonfinancial criteria, but they do not consider corporate income tax factor.
2.1. 7.2. Scale of criteria
Generally, scale of criteria is divided into five different levels from 20 to 100
points. Each criterion has a certain weight. The points of each criterion are
calculated as following: multiply one in five level points by weights,
respectively. Each weight of criteria reflects the important degree of criteria.
Points of businesses are calculated by plusing total points of criteria which
mutiplied with the weights.
2.2. Some model of credit rating
2.2.1. Moody's rating analysis
According to Michel Crouhy et al (2000), Moody's is considered to have
expertise in credit rating. The credit rating process includes quantitative,
qualitative and legal analyses. The quantitative analysis is mainly based on the
firm's financial reports. The qualitative is concerned with management quality,
reviews firm's competitive situation as well as an assessment of expected growth
within firm's industry plus the vulnerability to technological changes, regulatory
changes, labor relations, but criteria of Moody's does not consider corporate
income tax factor.
10




Table 2.1 shows that long-term and short-term ratings are built by Moody's.
The long-term rating has 20 ranks from Aaa to C and the short-terms rating are
divisible into only four notches, as Prime-1, Prime-2, Prime-3, Not-Prime.
Table 2.1: Rating symbols long-term and short-term debt
Long-term

Interpretation

Short-term

Highest credit quality

Aaa
Aal
Aa2

Prime-1

High credit quality

Aa3
Investment-

Al
A2

grade
Prime-2

Strong payment capability

ratings

A3
Baal
Baa2

Prime-3

Adequate payment capability. Last
rating investment-grade

Baa3
Bal
Speculative. Credit risk developing,

Ba2

due to economic changes

Ba3

Speculativegrade

Bl
B2

Not Prime

Highly speculative, credit risk

ratings

present, with limited margin safety

B3
Caal

High default risk, capacity

Caa2

depending on sustained, favourable

Caa3

conditions

Ca,C

Although prospect of partial
recovery

May be m
default

Default

Source: Moody's (2004)

11


2.2.2. Z-score model of Altman

In order to strengthening the predicted bankruptcy of enterprises in credit
rating model, commercial banks use predict models which have many variables.
Methods are used to predict the risk failure of businesses had been built and
published. However, Z-score model of Altman has been tested and widely
accepted.
Credit scoring model is built by Altman ( 1981 ), the first development. Then
Steele (1984), Morris (1997) and other researchers develop more. The general
model is Z = c + "L... c r .
I

I

Where as: c: constant; ri: financial ratios and non-financial criteria is used as
variables; ci: coefficients of each variables in the model; i: variables.
The model is developed by Altman for publicly traded manufacturing firms in
United States Altman as follows:
Z
Where

= 1.2Xt + 1.4X2 + 3.3XJ + 0.6X 4 + 1.0 X 5

Z > 2.99 indicate non-bankruptcy,
2.2 < Z < 2.99 indicate a gray area,

And

Z < 1.80 indicate bankruptcy prediction

Of which:


X 1 = (Current Assets - Current liabilities) I Total Assets: measure the

density of working capital in total assets


X 2 = Retained Earnings I Total Assets: measurement ability profits



X3 =Earnings before Interest and Taxes I Total Assets: This is the most

important coefficient. Profit is the top goal and is determined at the existence
of businesses. Future loans added to the charges also show the ability to create
income for enterprises.



X4 =Market Value of Equity I Book Value of Total Liabilities: measuring

stamina of enterprises when the property of firms decline.
12




X5 = Sales I Total Assets: the ability to create sales of property

* Advantages from the model mentioned above measure risk credit by scores
saying that it is relatively simple. But, this model has a few disadvantages as
follow:
The model only allows classification borrowers with two groups as risk
and no risk. However, in practice the level of credit risk potential of each
customers is different such as slow to repaying interest expenses, and do not pay
interest expenses to lost all capital. Unconvincing reasons to show that the
number reflects the importance of indicators in the formula is invariant.
Z-Scores model of Altman Model do not include difficult criteria to
quantify, but I think it is an important role affecting level loans (reputation of
customers, the relationship between long-term banks and customers or
macroeconomic criteria such as fluctuations of economic cycles)
2.2.3. Credit rating of Credit information center (CIC)

Credit Information Center of State Bank implementation ranked trust
businesses under the guidelines of State Bank in Vietnam in order to standardize
the assessment of financial ratios criteria can apply for Commercial Bank. CIC is
currently using 11 financial ratios criteria, including current ratio, quick ratio,
inventory turnover ratio, receivable turnover ratio, total asset turnover ratio, debt
to equity ratio, debt to total asset ratio, return on asset ratio, return on common
equity ratio, net profit margin ratio, delinquency ratio to the grading guidelines in
Decision No 57/2002/QD-NHNN date 24 January, 2002. This model is clearly
limited by the appraisal lack of non-financial criteria. And this model do not
consider corporate income tax factor.
2.2.4. Credit rating VCB

Vietcombank build credit rating system with the principles of limited
maximum impact financial ratios criteria by designing non-financial criteria and
provide detailed instructions for the evaluation of credit rating.
13


. --- --- ------------------------------------------

The financial ratios criteria is assessed by the instructions of State Bank and
adjust a few statistics ratio by industry calculated from information VCB's credit
data. Those of non-financial criteria are built to supplement financial ratios
criteria. Each criterion was evaluated in the standard corresponding level of 5
points 20, 40, 60, 80, 100 (initial points). Depending on the importance of each
criteria group and criteria have different weight. Based on the total points
achieved after initial points with weighted to ratings.
Enterprises are classified in three groups: large, medium and small. Each
group size will be scoring system of 14 financial ratios criteria corresponding to
the 4 group-farm forestry industries- fishing, trade and services, construction and
industry. Financial ratios criteria including liquidity ratios (current ratio, quick
ratio); activity ratios (receivable turnover ratio, inventory turnover ratio, total
asset turnover ratio); debt ratios (debt to total assets ratio, debt to equity ratio,
delinquency ratio), profitability ratios (return on asset ratio, return on common
equity ratio, net profit margin ratio), but credit rating criteria of VCB do not
consider corporate income tax factor.
Table 2.2: Weighted points of non-financial criteria
State-owned

Enterprises with

Other

enterprises

foreign investment

business

20%

20%

27%

Management

27%

33%

27%

Relations with banks

33%

33%

31%

External criteria

7%

7%

7%

Other activities

13%

7%

9%

Criteria

Ability to pay debts
from cash flow

Source: VCB, Ernst & Young (2008)
Table 2.2 shows that weighted points of non-financial criteria including
ability to repay debts from cash flow, management quality, relations with banks,
14


business environment and other activities. In addition, credit rating of enterprises
are categorized by three groups is state-owned enterprises, enterprises with
foreign investment and the other business in the weigh points of non-financial
criteria. And categorized companies by two groups are businesses have been
audited and not audited as presented in Table 2.3 and 2.4.
Table 2.3: Weighted points of financial ratios and non-financial criteria (not
audited)
State-owned

Other

Enterprises with

enterprises

business

foreign investment

Financial ratios

40%

35%

50%

Non-financial

60%

65%

50%

Criteria

Source: VCB, Ernst & Young (2008)
Table 2.4: Weighted points of financial ratios and non-financial criteria
(audited)
State-owned

Other

Enterprises with

enterprises

business

foreign investment

Financial ratios

60%

55%

60%

Non-financial

40%

45%

40%

Criteria

Source: VCB, Ernst & Young (2008)
Based on the total points achieved as the calculation is presented above, VCB
usually uses the following 10 ranks" AAA, AA, A, BBB, BB, B, CCC, CC, C,
D" from highest to lowest to denote the loaning enterprises credit rating classes
as presented in Table 2.5.

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