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Saturday, June 24, 2017 | MANILA, PHILIPPINES
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   banking report
Date posted: Monday, May 29, 2017 | Manila, Philippines

1st Quarter Banking Report (2017)

Stability defines legacy of Tetangco-era banking system

‘RESILIENCE’ best describes the Philippine banking sector’s performance over the last 12 years -- a period marred by external shocks of varying magnitudes.

When Bangko Sentral ng Pilipinas (BSP) Gov. Amando M. Tetangco, Jr. hands over the reins by the end of next month, his successor will inherit a banking system that has joined the ranks of the strongest -- albeit still among the smallest -- in developing Asia.

The capital adequacy ratio (CAR) of the Philippine banking system has kept well above the international minimum standard of 8% throughout those 12 years, even staying in the double-digit territory at the depths of the Global Financial Crisis (GFC).

Banks’ asset quality has improved substantially, with non-performing loan (NPL) ratios settling in the low single-digits in recent years.

Financial intermediation in the Philippines however remains middling, even as the financial sector’s share of domestic credit has risen close to 60% of the economy. In contrast, domestic credit provided by the financial sector in neighboring Malaysia, Singapore, Thailand and Vietnam has exceeded their respective gross domestic products (GDP) by at least a fifth.

Ambreesh Srivastava, head of Fitch Ratings’ South & Southeast Asian Financial Institutions team, said the Philippine banking sector improved over the last few years, adding that it used to be in the lower BB (BB-) level. At present, it is within the BBB category, the lowest for investment-grade debtors.

“[I]f we were to look at the major banks in the Philippines, their ratings also used to be in the low BB (BB-) range. Now, we can see that the largest banks’ ratings in Philippines (BPI, BDO and Metrobank) are already in our investment grade range while the rest of the banking system has also become a lot stronger,” Mr. Srivastava said.

He said the local banking sector will “stand out a lot better” compared with less developed countries like Vietnam, but “not be as strong” as Singapore and Malaysia.

Simon Chen, vice-president and senior analyst at Moody’s Investors Service agreed: “The banking system has benefited from the robust growth of the Philippine economy in recent years, which has supported the domestic demand for credit among businesses and individuals.”

“At the same time, the regulatory environment has kept pace with global developments and broadly ensured that the sector as a whole remains resilient to both external headwinds and domestic pressures,” he added.

ASIAN FINANCIAL CRISIS
Philippine banks have come a long way since Mr. Tetangco first took on the job of BSP governor in 2005. Eight years after the Asian Financial Crisis struck, lenders were still sifting through their books to identify more soured assets they could unload.

The Special Purpose Vehicle (SPV) Act was expiring, but disposals at mid-2005 comprised only less than a fifth of the P520-billion worth of unproductive assets logged when the law came into effect three years before. When the SPV law expired that year, the stock of non-earning assets comprised under a tenth of the industry’s combined P4.5-trillion in gross assets.

Consequently, the banking industry was pushing for a two-year extension of the tax breaks for bad asset sales. While the SPV law cut NPL levels to the high single-digits in 2005 from double-digits just the year before, the BSP was hoping an extension would allow the industry to shed at least P100 billion more of toxic loans and unproductive real and other properties owned or acquired (ROPOA).

“If you look at credit growth, we can see that back in 2005, the loan expansion was weak amid the sector’s restructuring effort,” Fitch’s Mr. Srivastava said.

A high level of NPLs has an insidious effect on credit, making it less affordable, thus less available. At the depths of the Asian crisis, the banking industry’s loan portfolio contracted, as bank lending rates hit the high-teens.

Banks naturally are more averse to lending, especially in the absence of a credit information system, a law establishing which was passed only in 2008 in the Philippines. Bad assets are a drag on earnings because banks would have to set aside provisions that otherwise could have been used to earn money.

Even creditworthy borrowers are penalized, as the credit crunch meant that they would find it more difficult to take out a loan. The Asian crisis was the worst possible time for all of these to happen, as it makes it harder for an economy that is financed largely by bank credit to claw back from a recession.

When the law extending the SPV tax perks expired in 2008, bad asset disposals fell short of the BSP’s target. Despite the underperformance, the banking industry’s NPL ratio was more than halved to 3.5%, or at levels seen before the Asian crisis.

Bank lending rates likewise had gone down to the high single-digits, whereas the industry’s total loan portfolio grew at double the pace of the previous year. Outside financial intermediation, credit was channeled to real estate, construction and manufacturing.

But barely had Philippine banks recovered from the Asian contagion, when another crisis loomed around the corner.

GLOBAL FINANCIAL CRISIS
US banks’ over-lending to subprime borrowers came home to roost, dealing a mortal blow to American icons such as Lehman Brothers and Bear Stearns. As the dust settled, it became clear that the damage was not restricted to the US, as European financial behemoths also took a hit, weighing down their governments. Credit markets froze, sending ripples across the globe.

BSP’s Mr. Tetangco recalls that he was in Washington, DC, leading a delegation to the annual IMF-World Bank (IMF-WB) meeting when news broke about the US’ subprime crisis: “The general environment there was very bleak. Financial market indices were falling each day. You watch the late news in the US, and wake up to find out Asia had reacted overnight, and US markets would again be lower from where they closed the day before.”



Aurelio R. Montinola III, who was Bank of the Philippine Islands (BPI) president at the time, was also at the IMF-WB meeting in Washington, and was in a huddle with representatives of some of the big-name global banks that eventually unraveled.

“We were all there...and then somebody said all the European bank (executives) had left, they went home na,” he said.

The collapse of big-name global financial institutions at the time came as a surprise to Mr. Montinola, who grew up in an industry that had been confident in the thought that a bank was the safest investment around.

“It [was] ironic. In the early days -- 2005 up, or even before -- the safest institution to invest in was a bank...That’s why people would put their money in time deposits, etc., (because) you don’t want to get into anything complicated,” he said. “But when 2008 happened, all the banks were at risk...We even had one subsidiary [which] we thought was the safest because 80% of our investments -- we just set up BPI Europe -- was of course in banks...And all of a sudden, it was like you could lose everything because the banks were at risk at the time.”

Mr. Tetangco cut short his trip, and called for a meeting with key officials of the Bankers’ Association of the Philippines (BAP), the country’s club of top-tier lenders, telling them what the BSP “was prepared to do.”

“(The BSP) opened its peso and US dollar repo windows, increased its rediscounting budget and eased on collateral valuation. Banks needed to be assured of the availability of liquidity, so they could, in turn, assure their clients, and avert any market panic,” Mr. Tetangco said.

“It was clear also that the cooperation of key market players was necessary. In other words, that dialogue with bankers was very critical. Because the GFC and the EU debt crises that followed were uncharted territory for all of us, ensuring market confidence was key to keeping the market stable at that time,” he added.

Mr. Montinola, who was also BAP president at the time, recalls top bankers grappling with the volatility in the financial markets.

“We had some quiet discussions, and we were able to work with the BSP for all of the banks to help and not push the foreign exchange rate...We asked everybody [for] a gentleman’s agreement... because the rates were jumping,” he said.

From an average of P40.9381 to the US dollar at the start of 2008, the exchange rate shot up to P49.1862 by November of the same year, before easing to P48.0942 by yearend.

“The situation with all industry groupings is, do you work together as a whole, or do you take your individual positions and take advantage of a competitive position?” Mr. Montinola said. “Fortunately at the time...all of the banks... agreed to work a certain way. Because you’re still free to pursue your own strategy, your marketing, but from a big picture... we were able to convince all the banks -- and all the banks cooperated -- and we were able to survive.”

PREVIOUS REFORMS PAY OFF
Despite the BSP’s preemptive move to cushion the domestic financial system from the spreading credit crunch, local lenders were not lining up to avail of the central bank’s liquidity windows, according to Mr. Tetangco.

“In part, because there was ample liquidity in the system, and in part, because our bankers were conservative and had maintained very minimal exposure -- less than one-half percent of total assets -- to subprime-type assets and derivatives,” he said.

“Moreover, bank lending standards were not compromised entering the GFC. Nevertheless, that dialogue helped secure market calm,” he added.

At the close of 2008, bank profitability was slashed by at least a third year on year, as gains from lenders’ trading business went down by a fourth. Even so, the double-digit growth in lending propped up net interest income, as the improvement in asset quality freed up more resources alongside the expansion in deposit liabilities.

While the Global Financial Crisis claimed big-name banks in the advanced economies, bank failures in the Philippines in contrast were contained within the rural banking sector, the most celebrated case being the Legacy Group, which the BSP ordered closed because of its failure to service its liabilities, among other unsound banking practices. Closures in the rural banking sector however posed no systemic risk, since it accounted for less than 0.5% of the domestic banking system’s resources.

On hindsight, reforms the BSP pursued in the wake of the Asian crisis -- including the enactment of the General Banking Law of 2000 as well as the SPV Act and its extension -- had paid off, helping minimize the impact of the Global Financial Crisis, Mr. Tetangco said.

“Over the years, the Philippine banking system (PBS) has sustained growth in assets, loans, deposit base, capitalization, without sacrificing loan quality and profitability,” he said.

In the succeeding years, bank profitability grew in the mid-teens, aided by a double-digit expansion in lending activity. Despite this growth, NPL ratios fell to historic lows of under 2%.

Fitch’s Mr. Srivastava noted that credit growth picked up “very briskly” from 2010 to 2015, partly due to the reforms undertaken by the Aquino administration, which sustained the government’s liability management program and introduced good-governance reforms.

Add to those several BSP initiatives, which according to Union Bank of the Philippines chief economist Ruben Carlo O. Asuncion, included the shift to a risk-based supervisory framework; the introduction of higher capital thresholds; the enhancement of BSP’s coordination efforts; liberalization of foreign ownership in the local banking system; the introduction of the interest rate corridor; and regulatory changes in line with the emergence of financial technology.

Banks, to be sure, didn’t take all of these sitting down. Take for example, the BSP’s acceleration of higher capital requirements under Basel 3, which could be met by issuing new securities, retaining earnings, restricting asset growth, or restructuring assets or liabilities or both -- any of which could be costly for a bank.

“I could tell you, for us, it increased our cost of doing business,” said Bank of the Philippine Islands (BPI) president and CEO Cezar P. Consing.

“But you could look at it as buying an insurance policy, [which] when you don’t need it, it’s just a cost, but when you need it, it really helped. If you look at it as an insurance policy, you’re basically investing in the safety of the system. It will probably pay-off,” he added.

The BSP’s gambit so far has paid off. Credit rating firms have since taken note of the domestic banking industry’s strength.

“We maintain a stable outlook on the Philippine banking system over the next 12-18 months, based on the robust fundamentals of the system, and the country’s macroeconomic stability,” said Moody’s Mr. Chen.

Fitch’s Mr. Srivastava agreed: “Our general outlook on Philippines banking industry is stable and this is particularly laudable for the industry especially when we see that many of the banking system in Asia Pacific, particularly in ASEAN countries, have a negative outlook.”

All told, the banking system’s total assets more than tripled from P4.319 trillion at end-2005 to P13.591 trillion last year. Loans also went up by 270.4% from P2.009 billion to P7.439 billion last year to comprise more than half of total assets. Loan growth was accompanied by cheaper credit, as bank lending rates were halved over the 12-year period.

CHALLENGES GOING FORWARD
Despite the growth and stability of the Philippine banking system, there are a number of emerging risks to its outlook, brought about by technological innovations, the sustained -- albeit occasionally interrupted -- pace of globalization, and demographic trends.

BSP’s Mr. Tetangco summed up these risks as follows: “[W]hile the banking system is currently in a position of strength, the retreat from multilateralism of some advanced economies (or de-globalization), asynchronous monetary policies, roll-back by some jurisdictions on financial market regulation, heightened risk from fintech and cybercrime; and geopolitical risks are some of the challenges that the industry needs to closely monitor moving forward.”

In the case of cybercrime, for example, the Philippine banking system was party to what is believed to be the biggest cyber-heist in the annals of money-laundering. The so-called Bangladesh Bank heist involved the use of both bank and non-bank financial intermediaries in the Philippines for the illegal electronic transfer of money from the South Asian central bank’s account with the US Federal Reserve Bank in New York.

The Bangladesh Bank heist strengthened Philippine banking regulators’ case for expanding supervision and examination of non-bank financial institutions, particularly remittance firms.

On a smaller scale, there had been the rash of skimming and scamming incidents involving the ATMs of even the Philippines’ biggest banks. The BSP had given banks a deadline to shift to the more secure EMV chip technology, with 90% of cards already equipped at the start of this year.

Then there’s the unfinished business of financial inclusion, an advocacy of the outgoing BSP chief. At 86% of Philippine households, the magnitude of people outside the reach of the banking system remains a huge challenge for the industry.

World Bank data show that only 31% of Filipino adults have bank accounts, which is below the 43% average for lower middle-income countries. Although the number of bank branches has increased by 1.6 times since 1998, many of these are in urbanized areas.

In recent years, telecom companies have given banks a run for their money. Given the higher penetration of mobile phones -- at close to 100%, according to mobile providers’ estimates -- the BSP has included this technology within the ambit of regulators’ financial inclusion initiatives.

Financial inclusion is not only a matter of providing greater access to the unbanked. From the point of view of domestic banks that are feeling the pressure of ample liquidity and greater competition among themselves and with foreign rivals, financial inclusion is increasingly viewed as a business proposition to, for starters, scale up their ability to mobilize low-cost funds.

“[T]he operating environment is shifting -- digitization, cybersecurity risks, social media, artificial intelligence, shifting consumer preferences, enhanced competition, regional integration moves for certain regional groupings, and policy uncertainty from retreat from multilateralism for other jurisdictions,” BSP’s Mr. Tetangco said.

With that, the Philippine banking industry has its work cut out. -- with a report from Christine Joyce S. Castañeda

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