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CIAO DATE: 2/00
Lessons Learned and Banking Sector Reform Priorities in the Philippines
Conference on Crisis & Credit, Restructuring Asia’s Financial Sector
October 1, 1999, New York
Introduction
It is a great honor for me to be invited to this very prestigious forum organized by the Asia Society to talk about the Philippine experience in banking reform.
As you are well aware, the Philippine banking system came under significant stress during the Asian financial crisis in 1997 and 1998. The ensuing instabilities took may forms: a substantial depreciation of the peso, a sharp increase in interest rates, a decline in corporate profits, and a general slowing down of the economy. The previous rapid growth in loan exposures to the property development sector and the rise in foreign currency borrowings rendered the balance sheet structures of banks extremely vulnerable to sudden changes in the weather. True enough, the ensuing financial storm weakened and eventually damaged these structures. Their formidable facades notwithstanding, our banking institutions did not escape unscathed from the crisis.
Impact of the Regional Crisis on the Banking Sector
The adverse effects took different dimensions.
The expansion of total banking resources slowed down to 1 percent in 1998 after averaging 28 percent in the previous five years. In fact, as of mid–1999, total bank assets were just 2 percent higher than the end–1998 level.
Banks earnings also declined since 1997. Return on equity fell from 16.3 percent in 1996 to 5.8 percent in 1998 and further to 1.8 percent in March 1999.
The impact of the crisis was most palpable in the dramatic increase in the stock of non–performing loans (NPLs) of financial institutions. NPLs of commercial banks as a ratio of total loan portfolio rose from 2.8 percent in December 1996 to 14.3 percent in July 1999.
These reverses were both cause and effect of the slackening of economic activity, as the financial and real sectors of the economy locked up with each other in a mutually reinforcing downward spiral. Fortunately, as it has been universally acknowledged, the descent of the spiral was not as deep in the Philippines as it was in some of our neighbors.
Our NPL levels, for example, are relatively moderate compared with those of other banking systems. Philippine banks were also able to maintain an adequate level of capitalization throughout the crisis period. The capital adequacy ratio of banks stood at 17.9 percent as of March 1999, in spite of the blows inflicted by the crisis on bank portfolios. This ratio is way above the minimum regulatory requirement of 10 percent or the BIS standard of 8 percent.
The corpses of collapsed banks marred the economic landscape of East Asia as a result of the crisis. In the Philippines, however, bank failures were relatively isolated cases and were confined mostly to small banking institutions.
Measured by assets, bank closures constituted less than 1 percent of the total resources of the banking system. There was thus only a limited disruption of the financial intermediation process even at the height of the crisis.
Lessons from the Crisis
In my view, the Philippine experience provides some useful lessons and insights to banks and businesses everywhere. Let me briefly focus on some of them.
1. A solid history of determined reforms helped our banking sector withstand the impact of the crisis.
The implementation of financial reforms in the past enhanced the resiliency of the domestic financial sector in responding to external and domestic shocks. Since the 1980s, measures were already being pursued to encourage greater competition, strengthen supervisory and regulatory systems, and sharpen the tools of monetary policy.
In the 1990s, these reform efforts were further intensified. Law created a new, stronger and independent central bank. Restrictions on the entry and operation of banks were eased, to allow, for example, the entry of ten new foreign banks and to liberalize bank branching policies. Certain prudential regulations were further tightened, such as the setting of a higher set of minimum capital requirements, liquidity cover on foreign currency liabilities, a cap on loans to the real estate sector, and new regulations on derivatives trading. Complementing these reforms were the close supervision of banks and monitoring of developments in the sector by the Bangko Sentral.
When the 1997 Asian financial crisis struck, the Bangko Sentral responded with a program of reforms aimed at improving further the capacity of banks to face adverse shocks and reinforcing the institutional framework to deal with troubled banks.
To upgrade prudential regulations, new measures were implemented, including:
To encourage sectoral consolidations, short–term incentives have been extended to mergers and consolidations in the banking industry.
The Bangko Sentral also improved its regulatory and supervisory practices and capabilities with the adoption of a host of reforms, such as the:
The transparency of the banking system is also being enhanced with the expansion of disclosure requirements. Financial institutions are now required to provide quarterly information on their non–performing loans, classified loans and other risk assets, amount of general and specific loan loss reserves, insider loans, and return on equity.
These new regulatory and supervisory initiatives have hastened the restructuring of the industry that we see today. We expect that the new regulatory environment will eventually help in strengthening our domestic financial system to enable it to cope better with the internationalization of financial markets and to meet the demands of an economy recovering from the crisis.
2. The pace of the implementation of reforms is as important as the breadth of reforms.
Even before the crisis, policymakers had long recognized that additional important reforms were needed to strengthen the banking sector. Thus, the Bangko Sentral placed a high priority on the push to align our prudential standards with international norms and to adopt internationally accepted best practices in supervision.
However, during the crisis, the concern arose that excessive speed could lead to breakdown: that is to say that the rapid and wholesale adoption of new regulatory norms might unduly push institutions into technical insolvency and trigger a systemic crisis. Crippling the financial system, in turn, would exacerbate the adverse impact of the crisis on the real economy and consequently derail our efforts at recovery.
Thus, the Bangko Sentral sought to achieve a balance between the need to improve prudential measures and the need to ensure that the pace of reforms would not lead to a crisis of its own. The Bangko Sentral has taken steps to ensure that existing as well as prospective prudential regulations do not unduly compromise the financial viability of fundamentally sound banks. It has adopted a reasonable phasing of the period required for complying with some of the new regulations. For example, in the case of the increase in minimum capitalization, the Bangko Sentral has set a build–up program that extends until the year 2000. In the case of the 2 percent general loan loss reserve, compliance was staggered over three stages within a period of two years.
The objective is to achieve a balance between fostering greater financial discipline among banks and creating an environment conducive to the growth of private enterprise.
3. The sequencing of the liberalization process is also critical.
It is a widely held view that, in the globalization process, the strengthening of bank supervision and regulation should precede the liberalization of international movements on capital account. This is to assure that the domestic financial system can cope with the complications that arise with the increased mobility of capital. When banks lack the necessary systems and skills to manage the risks associated with the intermediation of foreign capital flows, and when regulation and supervision of foreign exchange and liquidity exposures are weak, an aggressive liberalization of external capital account movements can lead to unsound positions taken by banks.
The Philippines was fortunate to have embarked on a long–series of market–oriented financial reforms before external capital account movements were significantly freed in the 1990s. As a result, the Philippine banking sector was relatively well prepared to cope with the external shocks that came when the Asian regional crisis struck.
4. Coordination among all industry participants and supervisory authorities is essential for the smooth implementation of reforms.
Sustaining stability in the banking system was supported and assured through the coordinated efforts of all the members of the financial services community.
Reform Priorities
To deepen the banking reforms and reinforce the Bangko Sentral’s ability to effectively regulate and supervise the banking industry, we are currently pushing for revisions to pertinent banking laws. Legislative measures are in the pipeline to amend the General Banking Act and the New Central Bank Act. All together, the combined proposed amendments to these laws seek to achieve the following:
Specific amendments have been put forward to reinforce the oversight function of the Bangko Sentral over the banking system. These proposals include making explicit the power of the Bangko Sentral to issue and revoke banking licenses, promulgate more objective guidelines and additional penalties for unsafe and unsound practices, and require periodic submission and publication of financial statements. They also seek to remove the limitation on the Bangko Sentral’s authority to examine banks on–site, now limited to only once every 12 months.
To improve banking prudential standards, the proposed amendments will grant the Monetary Board, the policymaking body of the Bangko Sentral, authority to adopt internationally accepted standards on banking operations, including those related to capital adequacy requirements. A strengthening of provisions on insider loans, on limits to borrowings and on the allied and non–allied investments of banks are also proposed.
To promote greater competition within the industry, we seek amendments aimed at allowing the entry of more foreign banks into the country, possibly within a limited time “window”, as well as permitting foreign players to acquire full ownership of distressed local banks.
Another priority of the reform efforts is the enhancement of Bangko Sentral’s ability to address threats to financial stability. Amendments to provisions regarding the Bangko Sentral’s lender–of–last–resort function will improve our capacity to cope with disruptions in the banking system.
The passage of all of these amendments will strengthen the Bangko Sentral’s effectiveness in discharging its mandate of providing policy directions in the areas of money, banking and credit and in supervising financial institutions.
Conclusion
Let me conclude by stressing that when all is said and done, what is done is more important than what is said. Our track record shows that we have backed up our pronouncements, however ambitious, with our performance, however difficult. We intend to improve on this record. We owe it to the international community. We owe it to our regional neighbors. We owe it to our trading partners. And most important of all, we owe it to ourselves.
Thank you and good day.
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