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Monday, October 23, 2017 | MANILA, PHILIPPINES
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   banking report
Date posted: Monday, November 28, 2016 | Manila, Philippines

3rd Quarter Banking Report (2016)

Are banks ready for Duterte’s rural offensive?

WHILE his war on drugs has drawn the most media coverage, if not commentary, Pres. Rodrigo R. Duterte has been circling the country advocating a shift from the unitary form of government to federalism.

Venting his frustrations at "imperial Manila," Mr. Duterte said other regions are not getting enough support from the government.

While a shift to a federal form will require rewriting of the Constitution, regional development might be inevitable given the country’s economic growth momentum.

Fifth on the Duterte administration’s 10-point agenda is to "promote rural and value chain development toward increasing agricultural and rural enterprise productivity and rural tourism," which can speed up development and linkage across regions.

Provinces surrounding Metro Manila and urban centers Cebu and Davao are being eyed by foreign investors. Tourism is also soaring and with the help of social media, hidden "gems" in far-flung areas are becoming attractions.

The business environment remains supportive. Liquidity is high and inflation continues to be manageable -- encouraging spending among consumers and businesses alike.

Banks are also aggressive in growing their network. Between 2010 and 2015, a total of 1,867 bank offices were added nationwide. As of June, another 177 banks were added to the system, bringing the overall count to 10,887.

Total assets of the Philippine banking system nearly doubled from P6.92 trillion in 2010 to P12.8 trillion as of September this year.

UNDERBANKED, UNBANKED
Despite the growth in branch networks, many areas remain underbanked or even unbanked, with the rural sector still beyond the reach of these lenders.

"BSP regulations on financial inclusion, rural banking, bank branching, credit risk management and lending policy, e-banking, corporate governance and risk management are essentially in place and substantial enough to sustain the growth of rural financing," said Bangko Sentral ng Pilipinas (BSP) Deputy Governor Nestor A. Espenilla, Jr.

"Key legislation, however, is needed to support the President’s plan, particularly item number five of the 10-point socioeconomic agenda," Mr. Espenilla said, citing the importance of amending the BSP charter so monetary authorities can firm up oversight of rural banks.

Republic Act 10000 or the Agri-Agra Reform Credit Act of 2009 mandated all banking institutions to set aside at least 25% of their loanable funds -- 15% for agricultural credit and 10% for agrarian reform credit.

At 47.51%, rural and cooperative banks have exceeded the minimum quota of loans for Agri-Agra. Their compliance rates for agrarian reform credit stood at 16.73% and for agricultural credit, 30.79%. These banks’ loans comprise 1.6% of the Philippine banking system’s total amount outstanding.

Universal and commercial banks (UKBs) and thrift banks, however, were way behind. Data as of June showed that these banks allotted only 13.76% and 11.37%, respectively, of their loan portfolios in this sector, most of which is for the agriculture sector.

The share of agriculture to gross domestic product (GDP) has contracted through the years. Accounting for nearly 30% of GDP in the 1940s, the contribution of agriculture, forestry and fishing has now dropped to as low as 8.4%.

`MISMATCH’
"There is a mismatch between the absorptive capacity of the agricultural sector and the loanable funds required by law to be set aside by the banking system," said Bankers Association of the Philippines (BAP) Managing Director Cesar O. Virtusio.

"The low compliance can be explained since these are privately owned funds, and banks, by their very nature, have the fiduciary obligation and responsibility to protect these funds (at high costs), [while] at the same time, provide an optimal rate of return," said Mr. Virtusio.

Loanable funds from universal and commercial banks make up more than 90% of the country’s banking system loan portfolio. Nearly half of their offices are concentrated in Metro Manila.

Jefferson A. Arapoc, an economist from the University of the Philippines-Los Baños (UPLB) campus, cited two reasons for the relatively small share of loans going to agriculture and to micro, small and medium enterprises (MSMEs).

"First, they are not like the manufacturing sector, which have backup, say assets. Second, their enterprise is very volatile in such a way that it can be easily affected by unfavorable weather events," he said.

Mr. Arapoc said farmers and fisher folk prefer less structured financial institutions like cooperatives due to their flexibility of payment terms as well as simpler terms and conditions.

Alvin P. Ang, economist at the Ateneo de Manila University agreed, "Most of the agrarian reform beneficiaries are from the informal sector. They do not benefit from banks which serve the formal sector."

Banks would rather be penalized than comply with the law, since lending to the rural sector creates greater risk.

"If you’re an established universal or commercial bank, you would rather pay the fine," Mr. Arapoc said.

ENCOURAGE NOT TO FOLLOW
In any event, other modes of complying with the law are available such as subscription to bonds issued by the two state-owned lenders, Development Bank of the Philippines and Land Bank of the Philippines.

"We have good laws but sometimes there are provisions that would encourage these banks not to follow rules," Mr. Arapoc said, referring to the penalty imposed for non-compliance.

Penalty for banks that do not comply with the Agri-Agra Act is equivalent to 0.5% of the amount of non-compliance or under compliance.

Philippine Institute for Development Studies (PIDS) president Gilberto S. Llanto offers this explanation: "Rural banks can more easily comply with the Agri-Agra law because they have better information on the rural clientele and have developed different techniques to manage credit and other types of risks typical of agriculture and agrarian economies. They are not always successful but generally, they perform much better than the bigger banks in this regard."

Other than the Agri-Agra Act, banks are also mandated to allocate another 10% of their loan portfolio to micro, small and medium enterprises (MSMEs). Eight percent will be apportioned for the micro and small businesses, and 2% for medium enterprises.

Banks had been short of the minimum compliance for lending to small and micro-enterprises, hitting only 3.96%. Their compliance with the loan quota for the medium enterprises was higher at 5.33%.



"SME lending is a different thing and the reported severe lack of financing to this sector despite various lending programs by both government and private financial institutions seems to indicate the inchoate character of current lending practices," Mr. Llanto said.

Failure to comply with the Magna Carta for Small Enterprises will cost banks more or less P500,000 depending on the degree of non-compliance or under compliance.

CHICKEN AND EGG?
"A bank’s presence helps mobilize capital formation. It also gives access to credit," said UPLB’s Mr. Arapoc. "It combines small savings in order to become available for loans to bigger businesses."

"The problem is that, a bank may not exist if a place is not yet developed. It needs clients. Aside from that, setting up a bank is costly," he said.

Ateneo’s Mr. Ang said investors look for complete business ancillaries wherein a bank is one form. Banks, which also seek profits, cannot thrive in places where there is little or no economic activity.

"Both are private sectors," he said, referring to banks and investors. "Ultimately, it is the role of the government to make the business environment conducive."

Mr. Ang said infrastructure, communications network and peace and order must first be fixed. Investors also take into account the education and skillsets of residents.

As the larger banks are torn between their responsibility to their clients and the mandate to spur development, BAP’s Mr. Virtusio said the government should provide newer forms of alternative compliance.

"We, therefore, propose to allow as alternative compliance the purchase of bonds issued by the national government, participation to any PPP [public-private partnership] projects of the government, and other modes of compliance as follows: development loans incentives or loans extended by banks to finance educational institutions, cooperatives, hospitals and other medical services, local government units and housing projects; loans for high-value crops projects; and any loan extended by banks to areas outside of Metro Manila, Metro Cebu and Metro Davao to promote rural development," Mr. Virtusio said.

TOWARDS FINANCIAL INCLUSION
"With the relaxation by the BSP of setting up of branches all over the country, commercial banks were able to set up even in third- or fourth-class municipalities," said Mr. Virtusio.

"Also, with current regulation, banks have set up satellite branches where they will be able to lend to farmers even without the setup of a full branch network," he added.

PIDS’ Mr. Llanto however places the burden of financial inclusion on the lenders: "The banking industry’s role is precisely to look for more effective ways of financial intermediation and today’s great challenge to this industry is to make finance inclusive."

He noted that some lenders are beginning to penetrate poverty-stricken areas defying the notion of being profit-oriented.

"Banks will go to where there is growth and great potential for profit-making, and where local conditions, including local governance, create a favorable investment climate," said Mr. Llanto.

"An interesting counterpoint to this traditional view is the bold decision of some enterprising microfinance banks to establish branches in some of the poorest areas of the country," he said.

These pioneers have succeeded in "fulfilling a social objective such as helping alleviate poverty and providing their shareholders and management with great profit opportunities," he added.

According to Mr. Espenilla, the BSP has been continuing enhancements in micro-finance related regulations "to expand the array of financial inclusion products and services available in the market, such as microfinance loans, microenterprise loans, housing microfinance, micro deposits and microinsurance."

As of June, 167 banks were engaged in micro-finance, with a total loan portfolio of P1.5 billion catering to 11.7 million micro borrowers.

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