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First Semester 2003 Status Report on the Philippine Financial System


The Bangko Sentral ng Pilipinas recently submitted to the President and the Congress the semestral Status Report on the Philippine Financial System as of end-June 2003 in compliance with Section 39 (c), Article V of the New Central Bank Act (R.A. No. 7653). The report also included selected articles on Bancassurance and Risk-Based Capital Requirement for Market Risks.

Overall Assessment

The Philippine Financial System continued to show further progress in the first half of 2003. Nothing spectacular to be sure, but remarkable enough given that every single gain had to be painstakingly coaxed from a domestic economy struggling valiantly to stay afloat in the face of major international and domestic disturbances.

Negative events that loomed large included the outbreak of war in Iraq and its global fallout as well as the regional crisis sparked by the SARS epidemic that virulently radiated out of Southern China. On the domestic front, seemingly incessant political hubbub repeatedly interrupted economic momentum. More fundamentally, an alarmingly large fiscal deficit presented a basic source of potential instability.

But mitigating the negatives, skillful economic management kept inflation firmly under control, interest rates at relative lows, and exchange rate volatility within manageable bounds. These positives proved sufficiently conducive in nurturing steady consumer demand and re-starting investment activity.

This was fertile enough ground particularly for the banking industry which reported moderate asset growth, further deposit expansion, improved capitalization and higher profitability.

Banking System Developments

The hopeful trend shown by the banking system at end-December 2002, with healthy growth on key financial indicators: resumption of lending, deposit growth, capital build-up and profit recovery, was extended through end-June 2003: 4.7 percent lending growth in customer loans (annualized), 6.5 percent increase in deposits, 5.0 percent hike in capital and 16.5 percent rebound in net income after tax (NIAT). (Table 1)

As of end-June 2003, the banking system’s aggregate resources stood at P3,529.1 billion, a growth of 5.8 percent or P193.6 billion over the same period a year ago. (Table 2)

The bulk of asset expansion came from private domestic universal banks, which grew by 9.4 percent or P175.0 billion from a year ago. This was followed by government banks, whose assets rose by 8.3 percent or P32.2 billion, rural banks by 10.0 percent or P7.7 billion and foreign banks (branches and subsidiaries) by 0.6 percent or P2.7 billion.

As shown in Chart 1, universal and commercial banks together held 90.3 percent (vs. 90.0 percent at end-June 2002) of the banking system’s total assets, followed by thrift banks at 7.3 percent (vs. 7.7 percent at end-June 2002), and rural banks at 2.4 percent (vs. 2.3 percent at end-June 2002).

Total loan portfolio (TLP) of the banking system amounted to P1,919.0 billion, which grew by 6.6 percent or P118.8 billion from P1,800.2 billion a year ago. Excluding interbank loans (IBL), TLP went up by 4.7 percent or P74.8 billion to P1,653.9 billion. IBL amounted to P265.2 billion or 13.8 percent of TLP, an increase of P44.0 billion or 19.9 percent from P221.2 billion a year ago.

The Manufacturing sector was still the main beneficiary of credit, followed by the Real Estate, Construction, Renting & Business Activity sector.

As a whole, the high non-performing loans (NPLs) and non-performing assets (NPAs) ratios of the banking system were still a source of concern, in spite of the year-on-year reduction in NPLs and NPAs.

NPLs at P284.5 billion were down by P32.0 billion or 10.1 percent from end-June 2002 level to P316.5 billion. This brought down NPL ratio to 15.0 percent from 17.6 percent a year ago. Hence, the NPL coverage ratio improved to 49.4 percent from 47.0 percent a year ago as the 5.6 percent loan loss reserves reduction was more than offset by the 10.1 percent drop in NPLs. Private domestic commercial banks posted the highest NPL ratio at 17.8 percent, while foreign banks (branches and subsidiaries) had the lowest NPL ratio at 5.1 percent.

Likewise, the ratio of NPA to gross assets fell to 13.7 percent from 14.9 percent a year ago due in part to the decline in NPLs as well as the reclassification of certain performing sales contract receivables (SCR) under BSP Circular No. 380 dated 28 March 2003. The resulting NPA coverage ratio of 30.8 percent at end-June 2003 was the highest coverage ratio achieved since the 1997 Asian financial crisis. Foreign banks (branches and subsidiaries) NPA ratio was still the lowest at 3.2 percent, while domestic banks posted an average NPA ratio of 15.3 percent. Furthermore, foreign banks (branches and subsidiaries) had much better NPA coverage ratio of 78.7 percent, compared with the 29.2 percent of domestic banks.

The deposit base continued to expand at end-June 2003, as aggregate deposit liabilities of the banking system reached P2,391.7 billion (vs. P2,245.4 billion at end-June 2002), rising by 6.5 percent or P146.3 billion. On the other hand, borrowings of the industry declined as total bills payable went down by 7.8 percent or P28.1 billion from P358.8 billion at end-June 2002 to P330.7 billion.

The combined capital accounts of the banking system grew by 5.0 percent to P476.0 billion from P453.2 billion at end-June 2002. The ratio of total capital accounts to total resources, however, slightly slid to 13.5 percent from 13.6 percent a year ago. Domestic universal banks accounted for 93.3 percent or P21.2 billion of the P22.7 billion year-on-year growth in capital accounts. The continued growth in capital accounts resulted in improved compliance with the prescribed minimum amount of capital.

The banking system’s estimated NIAT for the first half of 2003 amounted to P6.4 billion, a 16.5 percent improvement from P14.1 billion over the same period a year ago. More significantly, net operating income further improved by 25.3 percent on the back of balanced pick up in both net interest income and non-interest income.

Along with improving asset quality, banks implemented cost cutting schemes through consolidation of operations, shift to more cost-efficient methods, business process outsourcing, system rationalization and a host of other improvements. All together, these measures effectively brought down the cost-to-income (CTI) of the banking system to 70.0 percent during the first half of 2003 as shown in Table 3. However, the CTI of 70.0 percent is still a far cry from the 58.3 percent in 1997.

Comparatively speaking, foreign bank branches/subsidiaries were the most efficient with CTI of 60.6 percent, while rural/cooperative banks were the least cost efficient with CTI of 87.1 percent.

The return on assets (ROA) of 0.8 percent and return on equity (ROE) of 6.1 percent of the banking industry, as of end-June 2003, posted general improvement from last year’s ROA of 0.6 percent and ROE of 4.7 percent. But these ratios have yet to return to pre-1997 crisis levels.

Head offices of banks decreased from 912 offices at end-December 2002 to 906 offices at end-June 2003. Total operating banks at end-June 2003 comprised of 42 commercial banks (no change), 93 thrift banks (versus 94 at end-December 2002) and 771 rural banks (versus 776 at end-December 2002).

The reduction in the number of head offices was traced to 2 cases of rural bank mergers and 4 rural bank closures. Further, a thrift bank converted into a rural bank. Meanwhile, the total number of branches/other offices at end-June 2003 was unchanged from last semester’s 6,542.

Policy Initiatives

Banks will need to stay focused on basic reforms particularly improvements in internal credit process, the lowering of overhead costs, and further capital build-up. These elements are especially key to full recovery of the banking system.

Towards strengthening risk management, a key feature of the banking reform agenda is the upgrading of the regulatory framework in line with international standards and best practices. Significant progress is already being achieved in this area as evidenced by the stepped-up flow of new regulations implementing international standards. Strong emphasis is also placed on improved bank risk management not just for bank safety and soundness purposes but also so that destructive economic phenomena such as the formation of asset bubbles, other imbalances and misalignments will have less chance to occur.

In conjunction, stronger coordination is being arranged with domestic regulators so as to converge towards international best practice in the respective areas of banking, securities, and insurance. Initial Memorandum of Agreements (MOA) between the BSP and other regulators, such as the SEC and the PDIC have been finalized. This is work in progress that will continue to occupy the agenda of financial system regulators.

The promotion of good governance in banks and other financial institutions is another important program. Primary responsibility is squarely placed on the board of directors to ensure the proper conduct of banks. The values and practices of the directors are cascaded into the organizations through their policies and business decisions. Along this line, the BSP accredited seven (7) training providers to conduct corporate governance seminars to facilitate the implementation of the new requirement for the board of directors.

For the years 2002-2003, the training providers have offered a total of 181 corporate governance seminars attended by 6,170 participants including officers, consultants and stockholders. As of end-June 2003, 77 percent of the 5,760 directors of all banks have attended the required corporate governance seminar. The BSP aims to have all bank directors complete the process as a concrete step to fully empower the board of directors as a bedrock of good internal governance.

Beyond the strengthening of the banking system, the BSP recognizes the essential role of a well functioning and versatile domestic capital market as a critical element of a truly effective financial system. Historically, the banking system has played a dominant role in catering to the economy’s financing requirements. But there are limitations to that role primarily because of inherent funding mismatches where short-term liabilities in the form of deposits are mobilized to finance the constant need for long-term assets.

To address this need, the BSP is working closely with the banking industry and other market players to establish a legitimate debt securities market that can more flexibly handle developmental financing needs. This involves significant building of market infrastructure that can efficiently and safely handle debt securities transactions. Hopefully, by mid-2004, the Fixed Income Exchange shall have been established.

Summing up, in assessing the state of the financial system, it is important to look not just at the quantitative outcomes but also to take note of qualitative developments. Although the numbers are still relatively modest at this point in time, the underlying pace of reform in the financial system has been progressing quite rapidly. Since much of these involve institution building, it will take time for the initiatives to fully bear fruit. But without doubt, these will have a powerful positive impact on the economy’s future.

View: Philippine Banking System: Selected Performance Indicators (pdf)

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