The First Semester Developments: An Assessment
Merger and consolidation was a major theme of the Philippine financial system during the first half of 2000. This came about as banks and non-banks alike sought ways to rapidly gain financial and marketing strength amid the growing competition in the Philippine financial system.
Another interesting development was the Philippine financial system’s growing interest in micro financing activities as a way of expanding business lines. Initiatives towards this end also dovetailed with the government’s call for a more active support for priority development projects involving the lower income groups. Further pursuits in this area were expected to pick up towards the end of 2000.
On the regulatory front, the Bangko Sentral stepped up its efforts aimed at rationalizing existing policies, rules and regulations in the supervision and examination of financial institutions. Issuances during the semester further prompted the supervised and regulated entities to adhere strictly to prescribed prudential guidelines. Particular attention was given to those relating to the promotion of the modernization of risk management systems and practices, enhanced financial transparency and good corporate governance.
To further speed up the creation of bigger and stronger banks, an enhanced incentive package for mergers and consolidations was offered (Box 1).
In response to the increasing number of banks offering electronic banking services, the BSP issued new regulations to ensure that adequate risk management systems are in place to protect the bank and its customers.
Revised rules and regulations on loan classification was also among the major regulatory changes introduced this semester (Appendix 1). This is to promote greater vigilance of banks in protecting the quality of their loan portfolio.
Moreover, the stage was set for a more accelerated upgrading to international standards of the Philippine financial system. This came about with passage into law of the New General Banking Law (R. A. No. 8789) on 23 May 2000.
Philippine financial institutions positively responded to the call for greater vigilance over the stability of the system as a whole. They focused their operations toward strengthening their ability to serve as the first line of defense against financial crisis. The beefing up of reserves against losses remained a major strategy toward this end. Simultaneously, improvements in the front and back offices were also undertaken through the use of modern technology. This enabled them to not only provide better service to clients but also to enhance risk management.
These concerted efforts of both the industry and the supervisory authority to further strengthen the financial system will go a long way toward reinforcing public confidence. At end-June 2000, the system remained fundamentally stable while remaining dynamic enough to constantly innovate to cope with the increasingly sophisticated requirements of the Philippine economy.
The Philippine Financial System: An Overview
The overall performance of the Philippine financial system during the first half of 2000 continued to reflect the difficult economic environment as evidenced by sluggish asset growth. The banking system grew by a meager 0.4 percent (Table 1). On the other hand, the non-bank sector registered a 3.6 percent semestral decline. As a result, the banking sector cemented further its dominance of the financial system with an increased share of 92.3 percent of total assets.
Asset growth was mainly pulled down by the contraction in lending by both banks and non-banks. This was only partly cushioned by accumulation of more liquid assets as part of a defensive strategy.
The growth in deposit liabilities also slowed down to 0.5 percent over the semester. The same trend was also observed in capital accounts which grew by just 0.3 percent. On the other hand, borrowings declined by 2.4 percent.
The main bright spot in the whole financial landscape was provided by the rural banking system and to some extent, the thrift banking system particularly savings and mortgage banks. These sub-groups continued to perform relatively well in terms of asset growth and earnings. The rural banking system benefited from a strong agricultural sector performance while thrift bank performance was positively influenced by a still healthy consumer demand.
Despite a diminished share, the number of institutions in the non-banking sector continued to increase due mainly to the establishment of new pawnshops. In contrast, the number of banking institutions contracted due to mergers and consolidations as well as bank closures.
Box 1. MERGERS AND CONSOLIDATIONS
On 19 April 2000, the Monetary Board approved the issuance of Circular No. 237, consolidating and clarifying all existing rules and regulations on mergers and consolidations of banks and other financial institutions (Section X112 of the Manual of Regulations for Banks and Section 4112Q of the Manual of Regulations for Non-bank Financial Institutions), as well as improving the incentive package. This was done to foster healthy competition between and among banks, bring about more and better financial services at lower cost, and promote stability and efficiency in the Philippine banking sector.
Merger and consolidation are distinguished as follows:
Merger is the absorption of one or more corporations by another existing corporation, which retains its identity and takes over the rights, privileges, franchises, and properties, and assumes all the liabilities and obligations of the absorbed corporation(s) in the same manner as if it had itself, incurred such liabilities or obligations. The absorbing corporation continues its existence while the life or lives of the other corporation(s) is/are terminated.
Consolidation is the union of two (2) or more corporations into a single new corporation, called the consolidated corporation, all the constituent corporations thereby ceasing to exist as separate entities. The consolidated corporation shall thereupon and thereafter possess all the rights, privileges, immunities, franchises and properties, and assume all the liabilities and obligations of each of the constituent corporations in the same manner as if it had itself incurred such liabilities or obligations.
In making available the additional incentives to mergers and consolidations, the Monetary Board also emphasized that even without incentives, the surviving or consolidated entity shall be viable. In line with this principle, the availment of these incentives, particularly the privilege of asset revaluation and recognition of goodwill, shall be subject to the following conditions:
1. That the surviving or consolidated entity will meet the prescribed minimum capital requirements even before considering the appraisal increments and goodwill, or there will be fresh capital infusion to meet said capital requirements; and
2. That the merger of consolidation will lead to a stronger entity in the long run as a result of cost savings and/or enhanced competitive position.
The improved incentive package is likewise available in cases involving the purchase or acquisition of majority or all of the outstanding shares of stock of a bank.
In general, the enhanced incentives can be classified into two (2) groups depending on the impact/benefits accruing to the participating institutions.
The first set of incentives, relating to the recognition of the revaluation of premises, improvements, and equipment in the books of accounts of the surviving entities, has the effect of increasing capitalization of the merged or consolidated financial institution. All other incentives merely exempt or relieve the merging or consolidating institutions from certain operational restrictions and/or requirements.
Incentives for merging or consolidating financial institutions included, among others, the following:
- The revaluation of bank premises, improvements and bank equipment of the institution, provided that such revaluation shall be based on fair valuation of the property conducted by a reputable appraisal company which shall be subject to review and approval by the BSP;
- Staggered booking of unbooked valuation reserves based upon the BSP examination and other capital adjustments resulting from the merger or consolidation over a maximum period of five (5) year;
- The temporary relief from full compliance with the prescribed net worth to risk assets ratio by the resulting bank, at the discretion of the Monetary Board, subject to certain conditions which the Monetary Board may prescribe;
- Amortization of goodwill up to a maximum period of 40 years, if warranted;
- Installment payment of outstanding penalties on legal reserve deficiencies and interest on overdrafts with the BSP as of the date of merger or consolidation over a period of one (1) year;
- The rediscounting of up to an amount equivalent to 150% of adjusted capital accounts for a period of one (1) year, reckoned from the date of merger or consolidation provided the merged/consolidated bank meets the required net worth to risk assets ratio and all of the other requirements for rediscounting;
- The possible grant to commercial banks, whose outstanding real estate loans exceed 20% of total loan portfolio, a one-year grace period within which to comply with the prescribed 20% ratio reckoned from the date of merger or consolidation;
- The restructuring/plan of payment of past due obligations of the proponents with the Bangko Sentral as of the date of merger/consolidation over a period not exceeding ten (10) years;
- In the case of rural banks, the grant of access to the BSP rediscounting window for a period of two (2) years from the date of merger or consolidation even if its past due ratio exceeds 25% of loan portfolio but not exceeding 30%, provided the merged/consolidated bank meets all other requirements (During the 2-year period, its rediscounting limit per application may be increased to an amount equivalent to the total rediscounting limit per application of each of the constituent banks before merger or consolidation.);
- Subject to the approval of the Monetary Board, allowing (a) concurrent officerships between a merged or consolidated bank/financial institution and another bank/financial institution; and (b) concurrent directorships in cases where a bank acquires shares of stock of another bank for the purpose of merging or consolidating the two (2) banks regardless of whether the banks belong to the same category or both have quasi-banking functions;
- Subject to other requirements on the establishment of branches, possible grant of authority for the establishment of branches by the merged or consolidated rural bank in the cities of Cebu and Davao, if same has put up the minimum capital requirements for these places; and
- The grant of automatic extension of five (5) years for retirement of government preferred shares to be reckoned from the date of merger/consolidation.
To date, more than 20 banks have already availed of the new incentive package. Still in the pipeline are 13 more applications for mergers and consolidations involving 24 banks and 2 non-bank financial institutions. According to a BSP internal study, even if all the prospective mergers and consolidation are completed, the market concentration in the Philippine banking industry is not likely to become anti-competitive. The industry’s Herfindahl-Hirschman Index or HHI (a measure of market concentration) is expected to remain way below the 1,800 index level where concerns are normally raised in other jurisdictions.
Chart 1. Comparative HHI (1990 to 2000)