Debt Classification

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BANKING AND FINANCE

NEW RULES ON DEBT CLASSIFICATION AND LOSS RESERVE

By Truong Nhat Quang
Duong Thu Ha

Following Decision No. 127/2005/QD-NHNN dated February 3, 2005 issuing the Regulations on Loans Extended by Credit Institutions to Customers, the State Bank of Vietnam (SBV) has enacted a number of legal documents aimed at improving credit quality and risk supervision and management, including Decision No. 493/2005/QD-NHNN dated April 22, 2005 issuing the Regulations on Classification of Debts and Loss Provisioning in Banking Operation of Credit Institutions. This article addresses certain significant provisions of Decision 493.

Scope of Application
According to Decision 493, all credit institutions operating in Vietnam (excluding the Bank for Social Policies) are subject to debt classification and loss provisioning requirements. Decision 493 however allows foreign bank branches licensed to operate in Vietnam, subject to SBV approval, to apply the loss provisioning policies of their parent banks.

The loss provisioning aims to compensate for credit losses of credit institutions. The loss reserve is calculated on the basis of the principal of debt and is treated as operating expenses of credit institutions.

"Debt" is broadly defined in Decision 493. "Debt" includes indebtedness or liability incurred under or in relation to loans, advances, overdrafts, financial leases, discounting or rediscounting of valuable papers, factoring (a new form of credit facility permitted in accordance with the Regulations on Factoring Transactions of Credit Institutions promulgated in conjunction with Decision No. 1096/2004/QD-NHNN dated September 6, 2004 of the SBV Governor) and "other forms of credit facility."

Classified Debt not Subject to Provisioning Requirements
Credit institutions are not required to make loss reserves with respect to (i) loans using funds entrusted by a third party who undertakes to be responsible for "settlement of risks" or (ii) loans funded by other credit institutions under syndicate arrangements for which the credit institution (presumably being the agent in this case) does not take any risk. Such loans are nevertheless subject to classification requirements set forth in Decision 493.

The expression "settlement of risks" could be well interpreted as the enforcement of collateral or the exercise of any other remedies for debt recovery. In a participation arrangement, the loan and security documents are normally signed between the lender and the borrower and the participant is not a party to such documents. As such, the participant does not have a direct recourse against the borrower (as it does not have a contractual relationship with the borrower) and it has to rely on the lender to enforce the collateral or exercise other remedies. A participant would therefore never undertake to enforce the collateral or exercise other remedies by itself. It may be the case that the lender is still required to make a loss reserve for the funds it receives under participation arrangements. Specific Provisioning and General Provisioning

Decision 493 provides for two types of loss provisioning, specific provisions and general provisions. Provisions established to absorb unidentified losses inherent in a credit institution’s loan portfolio are referred to as general provisions, and provisions established to absorb losses identified for specific loans are referred to as specific provisions. Specific provisions are already being implemented by credit

institutions and are now elaborated in Decision 493. General provisions are introduced for the first time in Decision 493 and are equal to 0.75% of the total debt classified from category 1 to category 4. Credit institutions are generally entitled to a 5 year phase-in period to implement Decision 493. All credit institutions except for the State owned commercial banks must implement the specific provisioning requirements immediately but have 5 years after the...
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