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Problem Statement

The State Bank of Vietnam have to classify and set a limit on the credit growth under the

circumstance that commercial banks in Vietnam are dealing with NPLs after the financial crisis in

2008, the big drop in the stock market and the freeze of real estate market. We can wonder why

State Bank focus on the credit growth, is it play an important role in the relationship with NPLs?

Is credit growth a good signal of economic development? If credit growth is a good signal of
economic development, should all banks put their priority on the lending activities? Will this

action lead to advantages or disadvantages in the future?

What is the source of growth? Commercial bank Vietnam decide to expand their lending basing
on the demand of the borrowers or just they desire to do as a growth competition with the

others? If they desire to do, how can they do? Will it affect their credit standards and the process
of credit appraisal?

Finally, I know that at least two researches in a recent conference about the economic
integration of ASEAN. These researches believe that credit growth could contribute to a decline
in NPLs? Does it mean commercial banks should growth more in lending to avoid NPLs?

I carry out this research to clarify these statements.

Research Objective

The research objective is to investigate the influence of commercials banks credit growth on
their credit quality under the control of some bank characteristics. To achieve this objectives, this
study attempts to answer the following question:

Does a change in the commercial banks credit growth lead to a change in banks credit quality

in the case of Dong Nai banking system?

Illustration of Banking Operation

The economy includes: (1) Banking system, (2) Depositors and (3) Borrowers.

(4) The depositors deposit money into the banking system. In other words, it is

mobilizing activities.

(5) Banks have to (6) pay interest to the depositors and they may withdraw their money.

In the other side, banks (7) evaluate (8) their customers and (9) lend them money.

The borrower will use (10) that money to invest their (11) business activities. The income

from their investments would be a source (12) for paying debt including (13) principals
and interests.

This research is conducted to focus on the relationship of the two yellow direction in the figure:

Lending and Paying debts. This relationship is indirectly affected by macroeconomic

determinants. In the case of positive effect from the economy, business activities become more
efficient, bank credit growth may positively relate to credit quality.

However, as a saying from Gavin and Hausmann (1996): Good time are bad times from learning.
It means in under the advantages of the expansionary phase of the economy, banks have high
probability of misevaluating their custormers. We call this externality information. In this phase
of the economy, borrowers may reach a plenty supply of credit, so they can use money

borrowed from somewhere to pay for the debts from somewhere else. Banks may appreciate
their customers for paying the debs on time but they cannot be aware of their true financial

In the case of negative effect of the economy, it is easy to see that more expand in lending

activities may lead to a decrease in credit quality due to inefficient business activities.
Different shifts

Now we move to the detail theory about the so-called shifts in the credit market, which can

explain the relationship between credit growth and credit quality.

There are two chart representing the expected return of banks from loans, the credit standards
and the total amount of loans.

Bank often expect higher return when they put a higher credit standard on their customer. Let

starting at the beginning equilibrium in the credit market. In the case of supply shift, banks start
to lower or loosen their credit standard from z1 to z2, then more borrowers meet the
requirements of banks, so banks can boost credit growth, the supply curve will shift from S1 to
S2. The expected return will decrease from re1 to re2. The decrease in credit standard may also

lead to the decrease in credit quality in the future, so this is the order of change: Credit standard
decrease, then credit growth increase and credit quality decrease afterward.

The second case is demand shift. In this case, their would be a shift-to-the-right in the demand
first. This shift may come from the need of optimizing capital structure or expanding business
activities. Banks will gradually see an increase in the loan demand, then they start to tighten
their credit standard from z1 to z2. Therefore, their credit quality will be improved in the future.
The order of change is Credit growth increase first, then credit standard increases and credit
quality also increases in the future.

The last shift is productivity shift, this shift is similar to the demand shift with the increase in loan

demand first. This increase come from the productivity of business activities. In this kind of
shifts, banks are flexible determining a rate of return from their customer and they can expected

different return at a specific credit standard level. The re curve may shift right or left. In this case,
credit growth will increase first, credit standard is ambiguous and credit quality will be improved

in the future due to the high productivity.

Measuring credit quality

Introduce 5 groups

Introduce NPLs and NPL ratio

Explain why not use NPL ratio, inverse measure


Base on previous studies, we use a dynamic panel data with the lagged effect of

independent variables as follow. We can see the eta term here are unobserved individual bank
characteristic. According to the nature of accounting data and the fact that banks decisions and
their effects would not be contemporaneous, the current level of explanatory variables will not

be included in the model.

Due to inefficiency of using common estimating method in the case of endogeneity and
the effect of unobserved factors, we transform this equation into first difference and apply the

Difference GMM to estimate the model. The model after transformation is as follow.

From this model, we can calculate the long-run coefficients basing on the coefficient alpha
and the betas of lags explanatory variables.


Basing on the econometric methodology and the literature review, the model specification

in the research would be.

This model include credit quality measure by non-performing loans over loans in group 1.
credit growth, credit growth integrating with dummy for too-big-to-fail hypothesis and control

factors. In the case of largest bank, dummy will equal to 1 and the effect of credit growth on

credit quality would be gamma plus delta.

This model is used to test the significance of coefficient gamma and delta. We will test

whether there is an effect of change in credit growth on the change of credit quality, and the

difference in this effect between three largest banks and the others.


We estimate 6 models. The first is baseline model which include only credit growth and
credit quality. Then we add in turn one of four control variables to gain model from 1 to 4 and

finally, we run a unrestricted model with all control variables.

First of all, we can see the lag of dependent variable is significant, this means credit quality

may be affect by itself in the past. Therefore, the long-run coefficient would be significant.

Secondly, we can see the positive and significant coefficient of credit growth at lag 3 and

4. Because the dependent variable is an inverse measure, these results show that the change in

credit growth have negative effect on the change of credit quality.

The long-run coefficient is also positive and significant, which prove for a long-run

negative effect of credit growth on credit quality.

Except for model (2), all of the rest models pass the test for autocorrelation and validity of


To sum up from the results, we have:

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Basing on the results and the literature review, we have three concluding remarks ad follows:

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For the Commercial banks

Credit Appraisal

The commercial banks have to be more cautious in appraising investment projects,

evaluating collaterals and supervising their customers capital usage especially new

customers in order to avoid bad borrowers.

In the relationship with customers, they should deploy and maintain solutions for their

customers to overcome difficulties in business activities; and classify borrowers

depending on their state of credit relationship to apply appropriate incentive policies.

It is not the right time for boosting credit growth rapidly in Dong Nai. Commercial banks

should keep track of the state of the local economy to implement credit policies timely
and efficiently.

Advantageous Industry

Moreover, commercial banks should focus greatly on projects on advantageous fields in

Dong Nai such as agriculture, production of exports, labor intensive and high technology
industries to ensure for the efficiency of loans and profitability.

Old and New NPLs controls

In addition, commercial banks need to control new NPLs, continue to handle old NPLs
and prepare sufficient provision for credit risk.

For The State Bank of Vietnam, Dong Nai branch (SBVDN)

The State Bank of Vietnam, Dong Nai branch (SBVDN) needs to supervise more closely on

credit growth of commercial banks, especially commercial banks with high NPL ratio.

Most importantly, the SBVDN should target the appropriate rate of credit growth,

avoiding high credit risk of weak commercial banks.

In addition, the SBVDN has to catch up with the conditions of local economy as well as

the real state of commercial banks activities in order to enhance the efficiency of administration

and operation.

Finally, they should coordinate with the local governments at various levels to improve

local economy, create good business environment for commercial banks, households and

For local government at various levels

Local government can help to create advantageous legal and business environment.

First, they need to facilitate households and enterprise in the proceedings of business
registration. It is the chance to increase the demand in credit market.

Second, they could coordinate with relevant departments to support for enterprises
outputs and stabilizing the markets.