The Bangko Sentral ng Pilipinas (BSP) recently submitted to the President and the Congress the semestral Status Report on the Philippine Financial System as of end-June 2004, in compliance with Section 39 (c), Article V of the New Central Bank Act (R.A. No. 7653). Also included in the report are non-banks with quasi-banking functions, offshore banks, and articles on tightened rules governing bank exposure to directors, officers, stockholders and their related interests (DOSRI) and the establishment of an internal credit risk rating system.
The banking system is once again reporting another semester of progress in the first half of 2004. Normally, that should be received as an unqualified bit of good news especially considering that it was secured during a period of high political uncertainty that surrounds the Presidential elections. Yet there is something disturbing about it. Stepping back from the cold numbers to take a broader view of the situation, it becomes clear that the pace of improvement in the financial system is in fact occurring in small incremental steps to make much of a difference to the economy. There is a need to rekindle the sense of urgency and to step up the pace of reforms.
During the period under review, the BSP took certain initiatives with potentially long-term beneficial consequences for the full reactivation of the financial system.
First, to jump start the clean-up of the enormous inventory of non-performing assets (NPAs) sitting unproductively in bank books, BSP issued Memorandum to All Banks/Non-Bank Financial Institutions with Quasi-Banking Functions (MAB/NBQB) dated 26 September 2003, as amended by MAB/NBQB dated 16 February 2004 providing for calibrated regulatory relief to banks that qualify for privileges under the SPV Act of 2002. The Circular essentially aims to ease the pain of banks in having to recognize potentially large losses resulting from the sale of NPAs at deep discounts. This is accomplished by allowing a staggering of loss recognition over a ten (10) year period for purposes of reckoning compliance with regulatory capital requirements subject only to full disclosure so that financial transparency is not unduly compromised and the public is not misled. However, to put pressure on the banks, this incentive is being reinforced with a clear signal from the BSP that forthcoming regulations that will implement international standards in the Philippines particularly Basle II and International Accounting Standards (IAS) will make it very costly to hold on to these non-performing assets. The BSP considers it a matter of urgent priority to address the NPA problem because it acts as an enormous drag on the financial system resulting in weak loan growth, low profitability, and a state of financial fragility.
Second, the BSP considers it highly essential to address the asset quality issue at the source, by dealing with fundamental weaknesses in the management of credit risk. Doing so will prevent the NPA problem from regenerating after it is cleaned up. The key initiatives are (1) Circular No. 414 dated 13 January 2004 providing for standards for the management of credit risk concentrations; (2) Circular No. 423 dated 13 March 2004 tightening the rules against excessive connected lending; and (3) Circular No. 439 dated 5 July 2004 mandating universal and commercial banks to adopt a formal internal credit grading system that conforms to rigorous minimum standards.
Third, the tightening of credit standards in the banking system requires making available realistic financing alternatives via the fast track development of the domestic capital market. Without a credible option, there will be considerable short-term risk of credit squeeze that can seize up the economy. The transition needs careful timing and attention as reforms are implemented. Here, multiple related initiatives are required of the BSP and other key actors. The BSP’s initial contributions include active nurturing of domestic rating agencies which play an important role in guiding the public to make sound investment decisions and in enforcing effective market discipline on issuers. For this purpose Circular No. 404 dated 19 September 2003 was issued setting accreditation standards for domestic credit rating agencies. The BSP also proceeded with the institutionalization of a third party custody system for securities with the issuance of Circular No. 428 dated 27 April 2004 providing for accreditation standards for third party custodians. This initiative is aimed at promoting capital market integrity for the protection of investors and laying the foundation for a deeper and more liquid secondary debt market through the development of a properly regulated securities borrowing and lending mechanism.
On a more specialized level, major reform initiatives were continued to promote sustainable microfinance that provides the long missing link that should connect the financial markets to the ordinary citizen particularly the enterprising poor. This has assumed special priority for the BSP. And it has delivered primarily by creating a favorable regulatory environment for microfinance and by its open advocacy for sustainable microfinance practice. The latest initiative in this regard was the issuance of Circular No. 409, which took effect on 1 January 2004, prescribing the careful monitoring of “portfolio at risk” and timely provisioning for losses on microcredits as a matter of best practice. By adopting a disciplined approach from the beginning, the BSP strongly believes that microfinance will be more successful in the Philippines over the long haul.
BSP’s active promotion of sustainable microfinance has borne fruit with its rapid spread. Today 176 rural, cooperative, and thrift banks participate without need for any subsidy, reaching out to over 530,000 microfinance clients. And the momentum keeps building up as more and more banks sign up. Internationally, the Philippines has come to be recognized as a leader in the commercialization of microfinance.
But beyond providing financial system access to the poor, microfinance as practiced in the Philippines has also helped in strengthening small banks. This has occurred because the technology is founded on honest-to-goodness basic but effective credit principles rather than on artificial incentives. The results are actually increasingly evident from the comparatively strong performance of the rural banking industry in recent years especially in regions that are known to be actively participating in microfinance.
Summing up, in spite of the rather incremental progress so far in terms of actual results, the seeds for a stronger, more robust financial system are actually being continuously sown. The reform process needs to be sustained notwithstanding the short-term difficulties and challenges. It will be eventually rewarded.
Banking System Developments
The Philippine banking system continued its steady growth in the first half of 2004 broadly in phase with the economy. Total assets expanded by 9.7 percent from a year ago to reach P3,873.3 billion as of end-June 2004. Asset growth was mainly supported by deposits, which rose by a 7-year high of 8.3 percent to reach P2,591.4 billion, as well as by borrowings. Overall leverage increased as capital accounts increased more slowly by 4.1 percent. Nevertheless, liquidity remains comfortable and capital adequacy remains well above the minimum. (Table 1)
Lending continued to accelerate but loan growth, exclusive of interbank loans (IBL), was still relatively modest at 4.5 percent. In sharp contrast, net investments, mostly in government securities, expanded rapidly by 24.4 percent as banks played the relatively steep yield curve. These trends underscore the continuing shift in asset composition, particularly in universal, commercial and thrift banks, towards greater share of investments in securities.
The cautious lending stance partly reflects lingering asset quality issues in the current portfolio. Although the situation is presently stable, progress towards full resolution of the overhang of non-performing assets from the last crisis was limited by the reluctance of many banks to recognize potentially large incremental losses associated with more rapid disposition of problem assets through bulk asset sales. Availment of privileges under the SPV law remained very modest at this point with transaction totaling only P3.2 billion in book value. Nevertheless, a number of big banks were poised to launch major asset sales in the second half of the year.
Only modest improvement in profitability was achieved in the period under review. A significant 22.4 percent improvement in net interest income and in fee-based income were fully offset by the sharp fall in trading income. Loss provisioning also slowed down to compensate for higher operating expenses as cost-to-income ratio slightly increased. Net income after tax (NIAT) improved by a modest 1.7 percent. Average return on equity (ROE) was estimated at 8.3 percent, still below a level that maybe considered sustainable in the long-run. (Table 2)
The big picture, however, marks the surprisingly strong performance of rural banks and cooperative banks as a group due to their profitable lending operations and increasing ability to contain costs. On the other hand, the performance of the thrift banking industry lagged the rest as group performance was pulled down by a number of problem banks in its ranks.
The total loan portfolio (TLP) of the banking system as of end-June 2004, amounted to P2,017.1 billion, a growth of 5.1 percent or P97.7 billion from P1,919.4 billion a year ago. Excluding IBL, TLP amounted to P1,725.5 billion, higher by 4.5 percent or P74.5 billion. IBL of P291.6 billion, registering an increment of 8.6 percent or P23.2 billion from P268.4 billion a year ago, took 14.5 percent share in TLP (up from 14.0 percent a year ago).
The industry sectors of Manufacturing and Real Estate, Construction, Renting and Business Activity were still the main beneficiaries of banking system credit, with a combined share of 35.2 percent of total bank lendings outstanding.
The overall picture of the asset quality of the banking system still leaves much to be desired. Although, the non-performing loans (NPL) ratio continued to slide with individual banks, bulk disposals are urgently needed to effectively slash the NPL ratio down to a tolerable single-digit figure. (Table 3)
Comparatively, foreign banks performed well with very low NPL and NPA ratios along with very high coverage ratios. On the other hand, domestic banks’ NPL ratio was still high at 15.2 percent with 49.6 percent coverage ratio and NPA ratio was 14.5 percent with 28.9 percent coverage ratio.
Among domestic banks, cooperative banks had the lowest NPL ratio of 11.8 percent and private domestic commercial banks had the highest at 19.4 percent. Government banks had the lowest NPA ratio of 10.9 percent, and also had the highest NPL coverage ratio of 72.9 percent and NPA coverage ratio of 46.6 percent.
NPLs at P271.5 billion was cut by 4.6 percent or P13.0 billion from year ago’s P284.5 billion. Together with TLP growth of P95.6 billion or 5.0 percent, NPL ratio improved to 13.6 percent from 15.0 percent a year ago.
Meantime, the NPL coverage ratio strengthened to 51.9 percent from 49.4 percent a year ago, as additional P0.3 billion or 0.2 percent loan loss reserves were booked, notwithstanding the drop in NPLs. Government banks in particular put up P2.5 billion or 13.2 percent in additional loan loss provisioning, despite the fall in their levels of NPL by P0.8 billion or 0.2 percent.
NPA to gross assets ratio continued to improve to 12.7 percent from 13.7 percent a year ago. The level of NPAs was up 1.7 percent or P8.7 billion, due to the increased foreclosure of collaterals that raised real and other properties owned or acquired (ROPOA) by 10.6 percent or P24.0 billion to P249.6 billion from year ago’s P225.6 billion. Corresponding NPA coverage ratio was slightly down to 30.6 percent from year ago’s 30.7 percent ratio.
With the end view of enhancing stability, the banking system struggled to build-up its capital base. The combined capital accounts as of end-June 2004 amounted to P495.4 billion, up by 4.1 percent or P19.5 billion from P475.9 billion a year ago.
Additional capital poured in by local branches of foreign banks amounted to P15.0 billion (P12.0 billion from net due to head offices and P3.0 billion from assigned capital). Private domestic universal and commercial banks further added P6.7 billion to capital.
The continued growth in capital accounts resulted in improved compliance with the prescribed minimum amount of capital.
As of end-December 2003, the average capital adequacy ratio (CAR) of the banking system both on solo and on consolidated basis went up further. On a solo basis, total qualifying capital (Tier 1 and Tier 2 less deductions) amounted to P348.6 billion representing 16.0 percent of risk-adjusted assets (vs. 15.5 percent last year). On a consolidated basis, CAR was at 17.4 percent (vs. 16.9 percent last year). On a solo basis, the increase in total qualifying capital was attributed to the rise in Tier 2 capital on account of issuances of eligible unsecured subordinated debt. On a consolidated basis, improvement in CAR was attributed also to the increase in Tier 2 capital coupled with the decline in deductions. Both solo and consolidated risk-weighted CARs were well above the minimum requirement of 10 percent.
The total number of head offices, branches and other offices of the banking system at end-June 2004 grew by 122 to 7,570 from 7,448 at end-June 2003. The net increase of 132 bank branches and other offices were mainly reopened branches/other offices of merged/converted banks, particularly of private domestic banks. On the other hand, the number of head offices of banking institutions was further trimmed down by 10 to 896 from 906 resulting from the closure of 7 rural/cooperative banks and 5 cases of mergers: 4 involving rural banks and 1 involving a thrift bank with a private domestic commercial bank. This was partly offset by the entry of 3 new rural banks including 1 microfinance-oriented rural bank. (Table 4)
The total operating banks consisted of 42 universal and commercial banks (no change from year ago), 89 thrift banks (vs. 93 at end-June 2003) and 765 rural/cooperative banks (vs. 771 at end-June 2003).
Innovations in e-banking services were a major driving force for change in the local banking industry. With e-banking, customers can perform transactions through a variety of popular interfaces including the Internet, web enabled cellphones and PDA devices (personal digital assistant). These improvements further enhanced customer convenience by making banking transactions feasible on a 24 by 7 basis from the workplace, from the home, and indeed from wherever the customer can use a mobile phone. The mobile phone is emerging as a potential major payment instrument to rival more established credit and debit cards.
Banks kept expanding the reach of the ATM network in an effort to enhance customer convenience and at the same time lower transaction cost for both customer and bank. At end-June 2004, the number of banks participating in an ATM network increased to 37 domestic banks (vs. 36 at end-December 2003) and 8 foreign banks (vs. 7 at end-December 2003). ATMs further expanded by 239 units (177 on-site and 62 off-site) at end-June 2004 for a nationwide total of 4,812 ATMs. Luzon with 103 units accounted for the biggest increment, followed by the National Capital Region (NCR) with 82 units, Visayas with 30 units and Mindanao with 24 units. NCR still had the most number of ATMs with 53.4 percent of total ATMs, followed by Luzon with 26.1 percent, Visayas with 12.1 percent and Mindanao with 8.4 percent.
At end-June 2004, 57 banks (41 domestic banks and 16 foreign banks) provided electronic banking services. Out of the 57 banks, 36 were universal and commercial banks (85.7 percent of the 42 operating universal and commercial banks) and 21 were thrift banks (23.6 percent of the 89 operating thrift banks).
Attachment: Philippine Banking System: Selected Performance Indicators (pdf)