The Bangko Sentral ng Pilipinas (BSP) recently released the Status Report on the Philippine Financial System for the second semester of 2006. The report provides an account of the performance of the banking system and other financial institutions such as non-banks with quasi-banking functions, offshore banks, and trust operations under BSP supervision during the first half of 2006. Also included in the report are articles on risk-based capital adequacy framework, guidelines on market and liquidity risk management, outsourcing of banking functions, consumer protection in electronic banking, and initiatives on improving the overseas Filipino worker (OFW) remittance environment.
The report is submitted to the President and the Congress, in compliance with Section 39 (c), Article V of the New Central Bank Act (R.A. No. 7653).
Following are the highlights of the report.
The Philippine financial system continued to rebound in 2006 as the seeds of sustained implementation of financial sector reforms are now markedly beginning to bear fruit. This year’s improving macroeconomic conditions likewise provided a favorable operating environment for banks to further strengthen their balance sheets and post higher profitability.
Key performance metrics of the banking system at end-December 2006 reflected overall soundness: double-digit expansions in assets, deposits, loans and capital accounts not to mention higher profit intake and better returns for banks’ shareholders on the back of more efficient bank operations. Asset quality has remarkably improved with non-performing loans (NPL) and non-performing assets (NPA) ratios nearing their 4 percent pre-crisis levels. In spite of higher loss provisioning levels and stricter alignment with international standards, banks also remained adequately capitalized with capital adequacy ratio (CAR), both on a solo and consolidated basis, still well above the minimum BSP regulatory requirement of 10 percent and the international benchmark of 8 percent. The increased issuance of hybrid financial instruments and plowback of profits to the banks’ capital base supported this year’s stronger bank capitalization.
With the foregoing slew of good news in place, the bigger question lies in the sustainability of the current growth momentum particularly in its ability to further propel the Philippine financial system into a path of steady recovery. In its bid to develop a more dynamic banking landscape defined by stronger financial institutions and effective market competition, the BSP has been resolute in encouraging banks to strengthen their balance sheets through the three main operative concepts: asset cleanup, capital buildup and industry consolidation.
On asset cleanup, the overhang of soured assets continued to put a strain on banks’ balance sheets. Considering how costly it will be to hold on to said portfolio of bad assets under Basel II come July 2007, banks have been heeding the call of the BSP to cleanup their books. The continuous unloading of remaining inventory of NPAs (either through SPV-related transactions or other innovative modes of asset disposition) has steadily improved the banking system’s overall asset quality in the last 10 years. While this is still high compared to other Asian countries, it needs to be emphasized that banks in the Philippines were cleaning up their books on their own without any form of government intervention (i.e., creation of state-owned asset management companies or special purpose vehicles) unlike in other economies. At end-December 2006, the NPL and NPA ratios of the banking system improved to 6.1 percent and 6.9 percent, respectively, from their high of 16.9 percent and 14.6 percent in 2001. This, in effect, made the current asset quality indicators less than 3.0 percentage points away from their pre-crisis ratios of 4.0 percent.
The general improvement in the banking system’s asset quality has been largely attributed to the implementation of Special Purpose Vehicle (SPV) Law of 2002, which facilitated the disposal of P96.7 billion worth of NPAs under its first phase of implementation. As of end-December 2006, the total volume of NPAs sold or transferred to SPV (under the second phase of implementation of the extended SPV Law or SPV II) amounted to P21.2 billion from the total of P31.2 billion worth of applications for SPV-related incentives. At the current pace of ongoing COE (certificate of eligibility) applications and approval, the BSP remained hopeful that the P100 billion target will be met, if not surpassed, at the end of implementation of SPV II. Outside SPV-related transactions, banks also conducted public auctions, debt write-offs and joint venture negotiations to further hasten the disposition of their bad assets.
On capital buildup, the increased issuance of hybrid financial instruments (i.e., unsecured subordinated debt or USD as hybrid Tier 1 and Tier 2 supplementary capital pursuant to Circular No. 503, as amended by Circular No. 528 dated 03 May 2006, and Circular No. 538 dated 04 August 2006) has augured well for the capital strengthening initiatives of banks in preparation for the implementation of Basel II by July 2007. Consequently, total USD-related capital of the banking system climbed by 48.9 percent to P75.6 billion in 2006 from P50.8 billion last year while their share to the banking system’s total resources rose to 1.6 percent from 1.2 percent in 2005.
On the status of industry consolidation, banks have demonstrated renewed interest to consolidate in 2006 with six (6) reported cases of mergers involving 12 banks and one (1) credit card company, one (1) case of rural bank consolidation involving two (2) banks, and two (2) cases of acquisitions involving four (4) banks. This has led to the general trimming of the overall bank structure with the reduction of 17 operating banks to 862 banks in 2006 from 879 banks last year.
Unlike its other Asian counterpart central banks, however, the BSP has taken a backseat by letting market forces drive the ongoing industry consolidation. Notably though, the combined challenges posed by stringent regulations, tougher foreign competition and more demanding banking/finance standards prompted local banks seeking greater efficiencies and higher profits to consolidate. Moving forward, the BSP envisions a more dynamic banking landscape dominated by globally competitive domestic financial institutions.
In the area of bank supervision and consumer protection, the BSP issued Circular No. 542 dated 1 September 2006 to promote greater consumer protection in view of increased usage of electronic-based bank products and services particularly by OFW families and other beneficiaries. The aim to expand the capture of cross-border Overseas Filipino Workers (OFW) remittances through the banking system has guided the enhancement of existing rules and regulations (Circular No. 534 dated 26 June 2006) to provide better transparency on remittance transactions and sustain the faith of OFW beneficiaries in the banking system.
Beyond banking reforms, the BSP also actively promotes the accelerated development of the domestic capital market to provide an alternative funding source for the economy. The BSP is set to develop the enabling framework for the effective participation of securities firms, specialized intermediaries (i.e., investment houses) and the institutional investors (i.e., mutual funds) in financial intermediation with the lifting of the moratorium on the grant of licenses on investment houses and financing companies to engage in quasi-banking functions.
In the area of microfinance, the BSP remained supportive of the national agenda on poverty alleviation through sustainable microfinance. As of end-December 2006, there were 212 banks engaged in microfinance with a total loan portfolio of P4.1 billion and serving a total of 650,104 clients.
Summing up, the Philippine financial system has started to strongly show a promise of sustained recovery but whether good tidings will be for long largely depends on the clear continuing commitment to genuine reforms of all stakeholders. To reform-minded supervisors within the BSP, harvest season should not be so far ahead.
Banking System Developments
The Philippine banking system significantly improved on its overall performance in 2006 amidst preparations for the implementation of Basel 2 in July 2007. Reform measures together with a string of favorable economic developments (i.e., stable inflation, stronger peso, positive business outlook, strong growth in exports, declining interest rates) provided a favorable business environment for banks. Consequently, banks reported stronger balance sheets and higher profitability during the year in review.
With a more streamlined and efficient physical network, total assets of the banking system stood at P4,863.7 billion as the system broke away from seven consecutive years of single-digit asset expansion with the 12.6 percent growth during the year. The growth was supported by respective growths in main sources of funds: deposits at 17.7 percent, capital accounts at 11.3 percent, other liabilities at 6.8 percent and issuances of unsecured subordinated debt at 48.9 percent.
The system remained principally funded by deposits at 71.9 percent (from 68.8 percent in 2005) and capital accounts at 11.7 percent (from 11.8 percent). The resultant shares of the banking system’s main source of funds were indicative of banks’ preference for low-cost financing and their increasing leveraged nature. Meanwhile, total resources were channeled mostly to loans, gross (net of IBL) at 38.3 percent (from 38.4 percent last year), investments (net) at 26.5 percent (from 29.9 percent), and held as ‘cash and due from banks’ at 13.0 percent (from 8.9 percent). Notably, banks were less efficient in their deposit mobilization this year as liquid assets (liquid assets-to-deposits ratio at 52.1 percent from last year’s 53.0 percent) cornered a bigger share of the system’s resources over lending (gross loans-to-deposits ratio fell to 69.4 percent from 72.5 percent) and investments.
Total loan portfolio (TLP), gross (exclusive of interbank loans) of the banking industry reached P1,994.1 billion from P1,804.4 billion as of end-December 2005. The double-digit 10.5 percent year-on-year expansion marked the highest growth rate in eight years. Upswings in consumer lending buoyed the system’s TLP on the back of strong private consumption resulting from steady inflow of OFW remittances.
The government’s significant progress in fiscal consolidation limited the need to borrow funds to finance its budget deficit, thereby diminishing the supply of higher yielding government securities in the market. This resulted to a slowdown in bank investment activities with investments, net unchanged from last year’s P1,289.8 billion.
The minimal growth in revenues from the banking industry’s main business of lending was offset by the sizeable profits earned from trading activities and fee-based services. The decline in interest rates and limited corporate demand put a snag on net interest income, rising by only 4.3 percent to P155.2 billion. The modest expansion in net interest income was compensated by the sharp hike in non-interest income by 32.5 percent to P91.0 billion as banks sought other non-traditional forms of banking activities to augmenting their profits from loans.
Backed by the double-digit expansion in bank lending and strong trading gains, the 13.2 percent increase in operating income outpaced the 12.9 percent build up in operating expenses. This resulted to a net income after tax (NIAT) of P57.4 billion, 28.9 percent higher than last year’s P44.5 billion. Higher bank earnings likewise provided better returns for banks’ shareholders with return on assets (ROA) and return on equity (ROE) of 1.3 percent and 10.6 percent, respectively.
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