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BSP Releases Report on the Philippine Financial System for the Second Semester 2005


The Bangko Sentral ng Pilipinas (BSP) recently released the Status Report on the Philippine Financial System for the second semester 2005.  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 second half of 2005.  Also included in the report are articles on the internal audit function, Basel II implementation roadmap, hybrid capital instruments and bank branching.

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.

Overall Assessment

The year ended in a positive note for the Philippine financial system, as it remained sound and stable in the midst of a tough operating environment.  The overall performance may be modest compared to the previous year but it was remarkable nonetheless considering these gains were achieved during an equally challenging year with the domestic economy facing external and internal disturbances.

The operating environment was marked by weak external trade, expanded value-added tax implementation, declining Treasury Bill (T-Bill) rates and incessant political concerns.

Nevertheless, the banking sector posted moderate expansion in assets, deposits and capital accounts. While credit expansion remains anemic due to weak corporate demand, banks’ aversion to credit risk from an overhang of non-performing loans and assets (NPL/NPA) and preference for government securities, bank lending (exclusive of interbank loans) recorded a modest 1.9 percent growth in 2005.  Banks also reported higher profitability with net income after tax (NIAT) posting a double-digit growth of 27.1 percent.

These hard numbers clearly indicate that the financial system remains fundamentally resilient and that reform efforts are gradually beginning to bear fruit.  However, underneath these industry average figures is the other part of the story:  there are remaining weak banks burdened with bad assets and limited capital to grow their businesses in an increasingly sophisticated financial services industry. For the Philippine financial system to be globally competitive and responsive to the needs of a growing domestic economy, the Bangko Sentral ng Pilipinas (BSP) has to respond to the call of keeping the ground fertile with continuing reforms. 

One important aspect is the urgent need to address the overhang of bad assets as they pose a threat to the overall soundness of the banking system. The implementation of the Special Purpose Vehicle (SPV) Law of 2002 has been instrumental in improving the asset quality of the banking system with the disposition of a total of P96.7 billion worth of NPAs through SPV-related transactions as of end-June 2005.

The impending implementation of SPV II is estimated to dispose another P100 billion at the minimum of the banking system’s inventory of remaining NPAs and bring the loan/asset quality ratios closer to their pre-crisis levels.

Apart from the SPV-related dispositions, banks will soon be allowed to enter into joint venture agreements (JVAs) with real estate developers to convert their idle real estate and other properties acquired (ROPA) into income generating assets. This new regulation is expected to create a favorable impact on the real estate market.

Another critical aspect is further realignment of local regulations with international standards, particularly those relating to corporate governance, risk management and capital adequacy of banks. Major regulations to be issued include the guidelines on new financial reporting package (FRP), supervision by risk, information technology and risk management, amendments to the Fit and Proper Rule and the prompt corrective action (PCA) framework.

Corporate governance reforms were firmly anchored on transparency and greater accountability of the Board of Directors.  Circular No. 494 was issued last 20 September 2005 to provide guidelines for the adoption of the Philippine Financial Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) based on the International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). The new accounting standards are seen to promote transparency, fairness and accountability in financial reporting.

The BSP has pursued further reforms in the area of corporate governance relative to the rules on independent directors, internal audit and the engagement of independent, external auditors for the annual financial audit of its supervised financial institutions. 

Parallel to this, the BSP has been steadily progressing with its Basel II implementation roadmap and gradually preparing the banking system for the phased-in implementation of the modified local capital adequacy framework. Consequently, banks reported slightly lower solvency ratios in 2005 as the system felt the brunt of regulatory tightening from the assignment of additional 25 percent to 125 percent risk weights on NPLs following the issuance of Circular No. 475 on 14 February 2005. 

Although the banking system’s capital adequacy ratio (CAR) remains well above regulatory and international standards, compliance with minimum capital requirements likewise fell to 77.8 percent from last year’s 79.1 percent as a result of tightened risk weights on assets.  The increasing number of banks failing to meet the minimum capitalization levels is also indicative of the dearth of capital, which can be addressed through innovative capital buildup or through merger and consolidation.

In response, the BSP issued Circular No. 503 on 22 December 2005 allowing banks to explore alternative and innovative ways to strengthen their capital base.  The new regulation recognizes the inclusion of hybrid financial instruments in the banks’ capital if their loss absorption characteristics mimic that of a common stock or perpetual non-cumulative preferred stock.
Meanwhile, the ongoing consolidation within the banking system resulted to improved operational efficiencies in 2005. However, it also led to greater concentration of banks in highly urbanized areas like the National Capital Region (NCR) leaving other areas largely underserved. Cognizant of this development, the moratorium on bank branching was partially lifted through the issuance of Circular No. 505 on 22 December 2005 to facilitate the expansion of financial services in underserved areas while giving banks some flexibility to respond to market opportunities.

The BSP has also opened up outsourcing possibilities and allowed a wide array of treasury, consumer and wealth management products in the market to foster a healthy competition in the financial system.

As a supervisor, it is crucial for the BSP to keep pace with the rapid transformation of the financial services industry.  Toward this end, the BSP has invested heavily on institutional reorganization and reengineering, personnel training and performance monitoring, data warehousing project and cooperative arrangements with counterpart domestic (i.e., Financial Sector Forum or the FSF) and foreign regulators.

Another key area in the BSP’s financial reform agenda is the accelerated development of the domestic capital market as an alternative pillar to the financial system.

Efforts to accelerate the development of the domestic capital market gained ground through the launching of the Fixed Income Exchange (FIE) early in the year.  Moreover, the role of credit rating agencies (CRAs) in capital market development was further reinforced with the issuance of Circular No. 473 on 01 February 2005 and the accreditation of Fitch Singapore, Pte Ltd., a foreign credit ratings company. Finally, the implementing rules of the third party securities custody system and the clearly defined role of third party custodians were aimed at proper delivery of purchased securities through a seamless interconnection of all market participants in a virtual trading platform.

Capital market reforms will be principally directed at further enhancement of enabling infrastructure, establishment of a centralized credit information bureau or CIB, widening of the pool of institutional investors and the establishment of better debt resolution framework.

Apart from these reform initiatives, the BSP has special interest in strengthening the country’s anti-money laundering mechanisms, promoting entrepreneurship through SME development and in helping alleviate poverty through sustainable microfinance.

Summing up, the emerging financial landscape becomes increasingly complex each year, leaving no room for complacency.  It is incumbent upon all players to enhance their core strength, conform to sound corporate governance practices and capitalize on their competitive advantage.  The road to a stronger financial system requires a lot of hard work and decisive yet, sometimes painful actions.  But the rewards of genuine reforms can be wide-ranging. In this sense, change is necessarily a good thing.

Banking System Developments

Banks posted modest growths in assets, deposits and capital accounts. While credit remained sluggish, banks recorded higher profitability on the back of improving operational efficiencies. Notably, these gains were achieved against the backdrop of increasing sophistication of the financial services industry and rapid alignment of local banking practices with international standards.

Total assets of the banking system expanded by 7.3 percent to P4,319.2 billion, largely supported by the upswing in deposit liabilities and bills payable. Universal and commercial banks continued to hold the bulk of industry’s resources at 89.3 percent while the remaining shares were accounted for by thrift banks at 8.0 percent and by rural and cooperative banks at 2.7 percent.

However, the system’s ample liquidity was still a challenge as the ratio of liquid assets to deposits lingered at 53.0 percent, albeit slightly lower than the 53.2 percent recorded in 2004.

Meantime, bank lending was sluggish with total loan portfolio (TLP), gross (exclusive of interbank loans) posting a modest growth of 1.9 percent compared to 4.0 percent last year. The averse lending behavior of banks is attributed to weak corporate demand and continuing overhang of non-performing assets (NPAs).  Outside the traditional loan recipients, consumer lending remained upbeat on the back of related upswings in residential real estate, automobile and credit card financing. This indicates that the domestic economy remains consumption-led, fueled by heavy inflows from overseas Filipino workers (OFW) remittances.

Although the uptrend in investments, net slowed down by 2.8 percent from 26.6 percent in 2004, banks were still inclined to park their excess funds in less risky government securities than lend to productive sectors in the absence of broad-based economic growth. Available government securities in the market, however, were limited with better fiscal management.

The brisk asset cleanup at the tail end of SPV Law implementation in 2005 resulted to significant reduction in non-performing loans (NPLs) and NPAs as well as improvement in industry’s asset quality indicators with the NPL/NPA ratios back to single-digit levels at the end of the year.

The banking system continued to be solvent in spite of slightly lower capital adequacy ratio (CAR) compared to last year. Regulatory tightening on the assignment of additional 25 percent to 125 percent risk weights for NPLs, following the issuance of Circular No. 472 on 14 February 2005, led to the overall reduction of CAR in 2005. Nevertheless, the banking system’s solvency ratio was still well above regulatory and international standards.

The industry posted better bottomline figures in 2005 with net income after tax (NIAT) increasing by 27.1 percent over the previous year. The ongoing consolidation of the industry resulted to improved operational efficiencies, which in turn, translated to higher profitability.

Meanwhile, the total number of head offices, branches, and other offices of the banking system reached 7,670, a minimal increase from previous year’s total of 7,612.  The number of bank head offices contracted to 879 from 893 resulting from several cases of bank mergers and closures within the year. The total operating banks consisted of 41 universal and commercial banks with 4,277 branches, 84 thrift banks with 1,209 branches, and 754 rural and cooperative banks with 1,305 branches.

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