Overview of the Philippines banking sector

Barnab Monnot 4 dcembre 2011

An ecient banking sector is a key component of a countrys growth, especially in newly industrialized countries like the Philippines. Though its banking system was historically plagued by scandals and oligopolistic practices 1 , the rebirth in 1993 of central bank (known as Bangko Sentral ng Pilipinas, or BSP) has subsequently fostered new trends in the regulation of nancial institutions. In this paper we give an overview of todays banking sector, focusing on the dierences between the various institutions and how they coexist in the nancial landscape. We begin our discussion with a comprehensive study of the BSPs role, which will lead us in a second step to a deeper understanding of the other institutions.

At the core of the Philippines banking sector : the BSP

In its own words, the BSP has two main roles : promote and maintain price stability and provide leadership in bringing about a strong nancial system 2 . The rst mission is achieved through the use of various monetary tools which it has at its disposition. The second mission relies on banking supervision and regulation, which we will study more in-depth in the following section. The adoption in January 2002 of a new ination targeting framework cemented the position of four monetary policies as the most important tools of the BSP : Open-market operations : These occur in one of these three ways : through repurchase agreements (leading to an increase in liquidity) and reverse repurchase agreements (leading to a decrease in liquidity) of government securities ; through outright transactions of government securities (same as repo and reverse repo without a reverse contract, leading to more long term eects) ; or through foreign exchange swaps. Acceptance of xed-term deposits : The deposits are made by banks or trust entities in a Special Deposit Account held by the BSP. Standing facilities : The BSP can provide credit to banks, with collateral. Reserve requirements : In order to function smoothly, the banks need adequate reserves. To inuence the ination trend, the BSP moreover asks the banks to keep a certain ratio of their reserves in Reserve Deposit Accounts held by the BSP. This is money that the banks will not be able to lend. 3 For instance, the BSPs last operations were to keep its rates (both policy rates and repo, reverse repo and SDA rates) at the same level, and to increase by one percent the ratio of required reserves (from August 5 onwards). We infer from this that the BSP is actually conducting a small contractionary monetary policy. The BSP has sole authority over the creation of new nancial institutions. It provides a few guidelines for the establishment of these new banks, including the following capital
1. Paul D. Hutchcroft, Booty Capitalism : The politics of banking in the Philippines, 1998 2. BSP website, http ://www.bsp.gov.ph/about/vision.asp 3. BSP website, http ://www.bsp.gov.ph/monetary/targeting.asp

requirements 4 :

We already see appear the four major types of banking institutions. Therefore, the role of the BSP can be easily compared to that of the HKMA in Hong Kong (but the BSP is the sole issuer of currency, unlike the HKMA). Concerning banking regulation, the BSP decided to implement the guidelines provided by the Basel II agreements, this for its biggest banks (the universal and commercial banks) and their subsidiaries. For other types of smaller, mostly rural banks, the BSP constructed another set of rules which it calls Basel 1.5 . Basel II requires the capital to be at 8% of risk-weighted assets. Basel 1.5 instead requires this percentage to be at 10% 6 . This can be linked to the countrys long history of bank runs, bad debts and subsequent fragility of the banking sector, which is particularly devastating in rural areas. Finally, the BSP ponctually issues IRR documents (Implementing Rules and Regulations) of various Republic Acts (RA) voted by the Philippines senate. Lastly, a quota on loans to the agricultural sector has been voted, the RA 10000 requiring banks to have at least 25% of their funds ready for providing loans to the rural sector 7 . The banks that do not comply with this regulation will have to pay a ne proportionate to the amount of under-compliance 8 . We just saw the overarching instance of the Philippines banking sector. It is now time to study its other components.

Dierent types of banking institutions make up the Philippines banking system

Lets start this discussion with a table that will give us an idea of the representation of each type of banks 9 :
4. Basic guidelines in establishing banks, BSP document 5. As of December 1st, the dollar to peso change is of 1USD = 43.50PHP 6. Risk-based capital adequacy framework for stand-alone thrift banks, rural banks and cooperative banks, BSP circular no. 688, May 26th, 2010 7. Agri-Agra guidelines out, Business Online, August 24, 2011 8. Implementing Rules and Regulations of the Agri-Agra Reform Credit Act of 2009, BSP RA10000 IRR, July 14, 2011 9. Physical network :Financial Instituitions under BSP supervision/regulation, BSP website, September 16, 2011

Among banks, we see a clear dominance of the sector by universal and commercial banks, and most particularly the former type. The rural banks are also of great importance. Their market is primarily oriented towards the agricultural sector and since this sector employs more than 30% of the workforce, the great number of rural banks doesnt come as a surprise. What could be more surprising is the very small number of foreign banks oces. Historically, this is due to very strong regulations that up to the beginning of the nineties forced the four authorized foreign banks to open no more than three branches. So, to circumvent this regulation, Citibank decided to go public in 1991. Now lets take a closer look at each type of banks.

2.1

Thrift banks

As we can see from the table, the total number of thrift banks was of 72 at the end of June 2011. The thrift banks can be seen as the smallest element of the non-rural and noncooperative banks. They have limited powers, and their market is rather oriented towards small scale businesses and individuals. They can accept deposits, open checking accounts and provide credit to its customers. Finally, they can accept deposits from the government and if they are granted the authorization, enter into money market operations (dealing of instruments with a maturity of one year or less). The three biggest banks in terms of assets are the BPI Family Savings Bank, the Philippines Savings Bank and the Planters Development Bank. The Philippines Postal Savings Bank is registered as a thrift bank. It is remarkable not because it ranks 16th in terms of assets but because it is one of the three state-owned banking institutions. It followed the principle of the usual postal savings banks even if it now operates independently of the Philippines postal system. 3

In recent years, the thrift banks have recorded a high level of growth (88% between 2005 and 2010 10 ). They reduced dramatically the amount of bad loans thanks to sounder methods of credit-lending. Their ratio of non-performing loans fell from 7.85% in end March 2010 to 6.56% one year later 11 .

2.2

Commercial banks

Commercial banks are at the number of 18 in end-June 2011. This type of bank has the same privileges as the thrift banks, plus others. For instance, it has the right to engage in foreign exchange operations, open demand accounts (accounts available to retrieve cash the quickest possible), provide letters of credit and deal with several types of debt securities (including bonds). Looking at their consolidated statement of condition on the BSP website, we see that the commercial banks are in good shape ratio wise. Their total capital accounts to total assets uctuated around 14 in the year 2011, while the same ratio was around 11 for both thrift banks and universal banks. As we will see, universal banks can enter activities of investment banking, perhaps one explanation of the comparatively lower ratio. Citibank is actually the biggest commercial bank, with assets valued at PHP 202.6 billion in end-March 2011 12 . Ranking banks by assets, we see that Citibank is tenth and that the 9 banks over are universal banks.

2.3

Universal banks

There exists 20 dierent universal banking institutions, including 3 government-owned (the Development Bank of the Philippines, the Land Bank of the Philippines and the AlAmanah Islamic Investment Bank of the Philippines). They dier from commercial banks in that they also have the right to practice investment banking, the natural function of the Philippines investment houses that are not regulated by the BSP but by the Philippines Securities and Exchange Commission. The three largest universal banks were in March 2011 in terms of assets Banco de Oro (PHP 965.1 billions), Metrobank (PHP 955.8 billions) and Bank of the Philippines Islands (PHP 751.8 billions). Many universal banks are controlled by family conglomerates, in an eort to diversify their portfolio of activites during the 1960s. Banco de Oro is aliated to the SM group while BPI belongs to the Ayala Corporation. Only four foreign banks are engaged in universal banking, including HSBC and Standard Chartered. Very recently, the BSP posted an encouraging statistic concerning the universal banks : their earnings grew by 12.2% between the beginning of the year and the end of the third quarter 13 . It is particularly good since both Banco de Oro and Metrobank had troubles because of their large exposure to Lehman Brothers, the latter having invested more than USD 20 million in their direct bonds 14 .

2.4

Rural and cooperative banks

If rural and cooperative banks do operate on the same market, the rural area, however they are run very dierently. Rural banks are privately owned and managed, and cooperative banks are instead organized by cooperatives 15 . They can extend credit and
10. 11. 12. 13. 14. 15. Thrift banks grow 88% in 2005-2010, ABS-CBNnews.com, March 24, 2011 Thrift banks cut bad loans, Business Inquirer, November 20, 2011 Largest commercial banks in the Philippines, businesstips.ph, July 21, 2011 Earnings of universal banks up 12% in 9 mos, The Philippine Star, November 23, 2011 Philippines banks set provisions for Lehman exposure, AFP, September 16, 2008 BSP website, http ://www.bsp.gov.ph/banking/bspsup.asp

provide other simple nancial services. They can also give a hand in the sourcing process of farmers. Just after the 2008 nancial crisis, some rural banks faced a bank run and were placed under receivership of the Philippines Deposit Insurance Corporation 16 , an institution under the control of the Department of Finance. These banks had been under surveillance before because of bad lending policies, and though the BSP issued statements saying that the whole system was itself rather sound, more banks went under receivership of the PDIC and are now being liquidated.

2.5

Non-bank institutions

Non-bank institutions exist under two dierent categories : Non-banks with quasi-banking functions : They are units that fund themselves through various means (issuances, obligations) and with at least 20 lenders to ll the borrowers account. Their ratio of non-performing loans is at 4.6%, a comforting number for such small institutions. Non-banks without quasi-banking functions : Among this category we nd NSSLAs (non-stock savings and loan associations) that are non-prot organizations for the saving of long-term nance and pawnshops that provide secured loans in exchange for collaterals.

Conclusion
Thanks largely to eective reforms and a tight control of the ination by the central bank, the Philippines banking sector is becoming more and more competitive. Though some weaknesses of the past persist in some areas like the rural banks sector, most banks have registered stable growth in spite of the recent economic downturn. This is very encouraging for the future of the nancial institutions and it certainly oers excellent opportunities in expanding our operations.

16. Rural bank run, 10 banks close in a week, Finance Manila, December 14, 2008